Australia and Japan

How distance and complementarity shape a remarkable commercial relationship

Foreword

This is a timely report. As the world contemplates how to deal with a once-in-ageneration financial crisis and its effects on the international economy, it reminds us that there is value not just in relationships that are new and fast-growing, but also in those that are substantial, stable, and have stood the test of time. Australia's commercial partnership with Japan is just that, and in my view that substance, stability and durability will be a critical factor contributing to the ability of both countries to weather the current uncertainty.

The report demonstrates how both history and economic structure have contributed to building a trade and investment relationship between Australia and Japan that will remain absolutely vital to the economic well-being of both countries for the foreseeable future-indeed, the more so in a world where energy, resource and food security appear increasingly likely to be at issue. At the same time it highlights how changes in Australia and Japan, as well as in the nature of trade and investment among countries in our region, throw open the potential for this bilateral relationship to assume a far greater significance regionally.

The new modes of international business that have developed during the 1990s and 2000s mean that an increasing proportion of commercial activity between Australian and Japanese firms happens in third countries. Patterns of investment are altering, too. Not only are Japanese companies taking larger shares and a more direct involvement in projects in Australia, but a small number of Australian companies (notably in the tourism industry) have shown that direct investment in Japan can yield significant benefits for both economies. The additional challenge for Australian businesses is to develop their relationships with Japanese firms in ways that tap into regional production networks. For companies and, especially, governments, the relationship needs to be thought of as more than just bilateral.

The Australia Japan Business Co-operation Committee is concerned that many Australian businesses outside the areas of traditional strength-agriculture, resources and energy-are unaware of the opportunities Japan offers. It has been a priority of mine as Chairman of that Committee to ensure a broadening of the business relationship into new areas of activity. This report is a useful contribution to that effort, and I hope it will be widely read by Australian businesses and policy-makers. My experience is that Japan offers rewards for companies that have quality products to sell or services to offer, and the perseverance to work with customers to ensure that their needs are met. Getting a foot in the door can require effort and patience, but the value Japanese customers place on long-term relationships means that, once in, there can be enormous and long-lasting benefits.

Sir Rod Eddington Chairman, Australia Japan Business Co-operation Committee

Overview

Australia and Japan enjoy a partnership of tremendous closeness that has both economic and strategic importance in the wider Asia-Pacific region. That partnership has been underpinned by Japan's position as Australia's largest single trading partner for all but a few years during the last three and a half decades-a position that was taken over by China in 2007, the same year in which China overtook the United States as Japan's largest merchandise trading partner. That change of ranking, along with the relatively low levels of economic growth in Japan itself over more than a decade, and the relatively stable nature of much of the huge commercial relationship between Australia and Japan, has resulted in a shift of the media spotlight towards China and the prospects for commercial relations with other emerging economies. The global financial crisis, which saw Japan slip into recession in late 2008, might seem to cast a further question mark over the state of the bilateral commercial relationship.

This report contains five central messages:

Any perceptions that Japan's absolute economic importance to Australia-and Australia's to Japan-are diminishing are misplaced.

Japan is still Australia's largest export market by a significant margin-and, as international competition for food, energy and resources grows, Australia's importance as a reliable and stable supplier of Japan's long-term needs will increase.
Japan remains the world's second-largest economy (at market exchange rates), with very high levels of per capita GDP. This means that the absolute magnitude of growth in the economy is very large even when growth rates are low, as has been the case in the recent past.
While direct imports of Japanese goods into Australia (‘made in Japan') have been growing slowly, Japanese companies are also responsible for many of Australia's manufactured imports from other countries in the region (‘made elsewhere by Japanese firms'), as the relationship transcends the purely bilateral and becomes regional in nature.
Similarly, Japanese firms operating offshore are contributing to the growth of Australia's exports to other countries in the region.
Japanese firms continue to be key investors in the development of Australia's energy, resources and agrifood industries.

Despite widespread perceptions to the contrary, Japan's low overall aggregate growth rates do not signify a lack of new opportunity for Australian companies to do business there.

The Japanese economy will continue to undergo significant change as a result of trends such as the ageing of Japan's population, changing savings and consumption patterns, the continuing integration of Japanese firms in the regional economy, and pressures to reduce energy consumption and greenhouse gas emissions.
Japanese policy-makers are also becoming increasingly conscious of the need to open their economy to greater international involvement.
Even relatively small growth in the world's second-largest economy combined with these structural changes will generate considerable business opportunities for firms in Australia.

Trade in traditional industry sectors will continue to represent the vast bulk of the Australia-Japan relationship; but there is potential for high growth in areas of emerging economic significance resulting from change in both countries.

Modelling carried out by the Australia-Japan Research Centre at the Australian National University for this report suggests that there is some scope for additional bilateral trade and investment in business and other services to become an area for future growth, although a number of impediments will need to be addressed.
An increasingly cooperative approach to bilateral trade and investment in agriculture and processed food could also yield rich dividends for both countries.
Firms in Australia should be aware of increasing investment by Japanese companies in China and other regional countries, which is linked to the rise of regional production networks, and alert to the consequent opportunities that arise in Japan and in the region.
Australian firms need to be open to taking another look at the Japanese market as traditional stereotypes about the difficulties of doing business there may no longer be accurate.

Capitalising on these new areas of opportunity will require active efforts by both business and government to maintain focus on Japan and to reduce ‘distance' in the business relationship, including through:

institutional measures, such as the free trade agreement currently under negotiation, intended to address ongoing barriers to bilateral trade and investment
ongoing promotion of people-to-people links, which are currently flagging in the face of fierce competition from other countries for the attention of both Australia and Japan, including through education, high-level business missions, and tourism.

It is in the interests of both Australian business and Australian governments to persevere in their efforts to maintain focus on Japan and to reduce distance in the business relationship.

Governments, which are rarely traders or investors themselves, benefit from the flow-on effects of mutually beneficial commercial ties into the broader political and strategic relationship.
Companies, which trade and invest when there are commercial gains from doing so (and for which broader political or strategic concerns are less relevant), may discover additional opportunities.

Introduction

Australia-Japan commercial relations-the morning after

The year 2007 was in many ways a landmark year in the history of Australia's commercial relationship with Japan. It was the 50th anniversary of the signing of the bilateral Agreement on Commerce that helped reinvigorate trade in the post-World War II period, and it saw the beginning in earnest of negotiations on a new trade agreement designed to integrate the two economies still further. The end of Australia's 2006-07 financial year marked the 40th anniversary of Japan overtaking Britain as Australia's largest export market, a position it still occupies by a significant margin.

If 2007 was a year of landmarks then the ‘morning after'-2008-has been more a year of questions. Figures released in early May 2008 confirmed that China had become the biggest trading partner of Australia (a position Japan had held for almost all of the previous three and a half decades). Japanese data released early in the year also showed that China had overtaken the United States as Japan's largest two-way merchandise trading partner. In both Australia and Japan there has been a heavy media spotlight on China and the other emerging giant, India, with much speculation about their potential to affect global economic dynamics and the Australian and Japanese economies. Still further questions and uncertainties have been posed by the acceleration, late in the year, of the global financial crisis and its growing impact on the real economy.

By contrast, there has been relatively little reporting on the Australia-Japan commercial relationship. But Japan remains of crucial significance to Australia's economy, and Australia to Japan's, even while the health, maturity and mutually beneficial nature of the bilateral commercial relationship keep it largely out of the news.

Each country remains the source of large quantities of goods and (to a lesser extent) services that the other needs, and bilateral trade, accordingly, continues to grow. Japanese requirements for Australian products continue to help fund the development of major Australian export industries, particularly in the energy sector. Although the global financial crisis has brought to an end-for how long is uncertain-some of the trends influencing the relationship, including high commodity prices, the weak yen and the appreciating Australian dollar, the fundamental complementarities that exist between Japan and Australia mean that this dynamic will continue into the future. The economic relationship, moreover, extends beyond direct bilateral dealings and contributes to both countries' growing trade and investment relations with a wide range of other economies, particularly in the Asia-Pacific region.

Chapter 1 of this report provides the factual backdrop for the remainder of the report. It outlines in detail some key characteristics of the bilateral commercial relationship, both demonstrating its ongoing size and vigour, and examining some of the characteristics giving rise to the challenges identified in subsequent chapters-notably the significant preponderance of primary products among the composition of Australian exports to Japan, and what appear to be relatively low levels of bilateral services trade.

Chapter 2 looks at two interacting factors that have shaped the bilateral commercial relationship to date. The first, which is well known, is the complementarity that has led to the burgeoning of trade and investment between the two economies. The second is the distance, in a multidimensional sense- cultural, administrative and political, geographic and economic-that has had to be overcome for the relationship to thrive.¹ It examines how these factors have evolved over time, and what they have meant for trade and investment between Australia and Japan.

At the same time as noting the relationship's importance, it must be recognised that change is afoot. The emergence of China and India, in particular, but also other large developing economies in Asia, is altering regional economic dynamics. As by far the largest developed economy in the region, with a per capita income many times that of its emerging rivals, Japan has until now been largely economically pre-eminent-but its situation is shifting towards that of first among equals. The per capita wealth gap will remain for many years to come, but the huge populations of China and India, in particular, as well as the dynamics of Japan's own demography, mean that the arithmetic of overall economic scale will change markedly. As this happens, issues surrounding the use and conservation of energy, resources and the environment will become ever more salient. These evolving economic dynamics, and the political changes that are bound to accompany them, are already presenting real challenges for the Australian and Japanese governments and must be expected to have an important impact on future commercial relations between the two countries.

Chapter 3, accordingly, looks at some of the changes taking place in the economies of Australia and Japan and in their regional engagement, and at the longer-term economic and demographic factors that are driving them. It focuses on the implications of the productivity challenges faced by both economies arising from three key themes: demographic developments, regional developments, and climate change and measures to address it.

Change within the two economies, of course, will have an impact on the commercial relationship as well. This impact will be expressed in different ways in different areas of the relationship. Chapter 4 returns to the concepts of complementarity and distance to examine what types of change might be predictable, what factors might encourage or inhibit growth in the relationship, and what governments and business might do to maximise the outcomes they seek.