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[Noah Smith] Japan rises as free trade leader as US sinks

Oct. 9, 2017 - 17:21 By Bloomberg
Back in the 1980s or 1990s, few would have predicted that Japan would become the standard-bearer of free trade. This is, after all, the country that once tried to ban foreign-made skis by claiming that Japanese snow was different from snow in other countries.

How times have changed. As the US sinks into protectionism, the Land of the Rising Sun is one of the few countries still pushing for trade agreements. Japan recently made a free trade deal with the European Union and is trying to keep the Trans-Pacific Partnership alive even after the US exited the deal.

Why the turnabout? One reason is probably geopolitical -- with the election of Donald Trump, the US’ commitment to its international alliances and to global security in general is looking less certain. Japan is probably trying to shore up its own alliances in Europe and the Pacific Rim.

A second reason is a desire for cheap products. Japanese wages have stagnated for a long time, and many Japanese workers depend on cheap products for their daily livelihoods. Trade agreements allow cheaper imports into a country.

A third reason is to force Japanese companies to raise their productivity. There is some evidence that international competition can have a salutary effect on both innovation and efficiency. Japan’s export-oriented companies, from giants like Toyota Motor to niche companies like zipper manufacturer YKK Group, are very productive, but represent only a modest portion of the economy. Companies that sell into the domestic Japanese market historically have tended to be considerably less efficient. By opening up trade with rich countries in the European Union, Japan’s leaders probably hope to force more of its corporate laggards to modernize their operations and corporate cultures.

But there’s a fourth reason for Japan’s recent enthusiasm for free trade -- the increasing importance of intellectual property in rich-country exports. This phenomenon has mostly flown under the radar, but is slowly changing the whole way that economists think about free trade.

For decades, Japan’s government made a conscious effort to strengthen the country’s intellectual-property system. The main reason is to encourage companies to innovate more. But Japanese companies’ increased focus on patenting has also helped them sell overseas. Though many countries have increased their patenting activities in the US, Japan is clearly in the lead.

This has reaped a bonanza for Japanese companies. Japan’s surplus in intellectual property trade has increased by a factor of five during the past decade, to about 2.4 trillion yen, or $21.3 billion. This has helped Japan to run a positive balance of trade, even as its surplus in goods trade has shrunk over the years.

As IP has become more important to Japan’s external economy, the country has become more active in promoting international patent protection. It has struggled to curb piracy of copyrighted media. The government has even helped farmers patent their fruits and vegetables abroad.

Of course, Japan isn’t the first country to make the transition from exporting goods to exporting ideas. When it comes to intellectual property revenue, the US is the clear leader.

Because intellectual property revenue tends to be undercounted, that probably means the US’ trade deficit isn’t as large as the numbers suggest.

So it looks like a country’s trade activity mirrors the natural course of its economic development. At first, a successful country industrializes by exporting cheap stuff, often with foreign technology that it imported, imitated or stole. But when its cost advantage dries up and it can no longer grow by copying foreign technology, a country has to innovate. And when innovation becomes a nation’s comparative advantage, it also becomes its source of export revenue.

But this shift makes it much more difficult to analyze the issue of trade agreements. Traditionally, economists tended to support free trade with simple arguments showing that allowing more trade makes each country better off. But protecting intellectual property isn’t the same thing as allowing trade. In one sense, the two are similar, since intellectual property protection allows buyers and sellers to put a price on an idea, moving it into the realm of the market. But in another sense it actually restricts trade, since it doesn’t allow people to sell things that they make using other people’s ideas.

This issue came up in the debate over the Trans-Pacific Partnership in the US. By harmonizing international intellectual property standards, the TPP would have boosted American companies’ profits, but often at the expense of consumers in other countries. That’s one reason the deal garnered opponents on both the right and the left, while receiving only lukewarm support from economists.

So while Japan’s push for free trade is smart, expect it to be met with skepticism in many quarters. The Japan-EU deal was successful, but these are rich countries with fairly similar levels of intellectual property protection -- and even so, intellectual property was a sticking point. When developing countries, and countries with very different intellectual property systems, are included in free trade accords, things may not go so smoothly.

In other words, the old era of free trade is over. The rising importance of intellectual property means that the justification for trade deals won’t be nearly as simple and utopian as in the past. Instead, the trade agreements of the future will be all about national interests and the difficult particulars of intellectual property and corporate interests.

By Noah Smith

Noah Smith is a Bloomberg View columnist. -- Ed.