Impact assessment

Executive summary for the final impact assessment of the UK-Japan Comprehensive Economic Partnership (CEPA)

Updated 26 February 2021

This executive summary duplicates the executive summary in the Final impact assessment of the agreement between the United Kingdom of Great Britain and Northern Ireland and Japan for a comprehensive economic partnership pdf

The UK and Japan are the world’s fifth and third largest economies respectively, together accounting for 9.2% of global gross domestic product (GDP) in 2018 (source: World Bank Indicators, GDP, current $). Total trade between the UK and Japan was worth an estimated £31.6 billion in 2019, accounting for 2.2% of total UK trade (source: Office for National Statistics, UK trade, quarterly trade in goods and services tables: October to December 2019). Japan was the sixth largest investor in the UK, with £89.2 billion invested in the UK in 2018 (source: Office for National Statistics, foreign direct investment totals for inward and outward flows, positions and earnings: 2017 to 2018). The UK was the fourth largest investor in Japan in the same year, with US$23.3 billion (£17.5 billion) invested in Japan (source: Japan External Trade Organisation, Japan’s Inward foreign direct investment 2018).

Since February 2019, the UK and Japan have traded under the terms of the EU-Japan Economic Partnership Agreement (EPA). The EU-Japan EPA will cease to apply in the UK following the end of the UK’s transition period in January 2021.

The UK and Japan have negotiated the Agreement between the United Kingdom of Great Britain and Northern Ireland and Japan for a Comprehensive Economic Partnership (referred to as UK-Japan CEPA in this document) which, if ratified, will enter into force in January 2021. The agreement aims to ensure the continuity of the existing UK-Japan trading relationship following the end of the UK’s transition period and to enhance the UK and Japan’s trade and investment relationship further.

This impact assessment aims to provide parliament and the public with a comprehensive assessment of the implementation of the UK-Japan CEPA in the long run prior to ratification of the agreement (this impact assessment provides an update to the analysis undertaken in the scoping assessment published in May 2020. The long run is generally assumed to represent around 15 years from implementation of the agreement). The assessment draws upon a wide range of data and evidence, including a modelling exercise undertaken by Professor Joe Francois to generate quantitative predictions of the scale and distribution of trade and macroeconomic impacts. The impacts of the agreement are assessed against a baseline where the UK and Japan do not have a free trade agreement, as this represents the default situation (that is, what would happen without ratification).

The impacts of the agreement

The negotiated UK-Japan CEPA is a deep and comprehensive trade agreement, covering 24 chapters. The agreement builds upon the existing trading and investment relationship set out in the EU-Japan EPA in several areas of mutual interest. The UK-Japan CEPA goes further than the EU agreement in a number of key areas such as digital trade, financial services and rules of origin. The Parliamentary report highlights areas where there are material changes and enhancements to the existing EU-Japan EPA (DIT, ‘The United Kingdom’s Future Trading Relationship with Japan’, 2020).

The provisions of the UK-Japan CEPA offer substantial reductions in tariffs and the removal or reduction in non-tariff measures affecting trade in goods and regulatory restrictions applying to services trade (note that tariff reductions apply to goods that meet Rules of Origin requirements). The agreement also includes provisions which enhance economic cooperation between the UK and Japan, provide greater certainty to exporters and investors and encourage utilisation of the agreement by small and medium-sized businesses (SMEs).

Enhanced trade and investment

Reduced trade costs and increased trade

Trade costs are the costs associated with trading internationally across borders and can be significant. The UK-Japan CEPA is expected to reduce tariff and non-tariff trade costs between the UK and Japan. In line with the negotiated tariff schedules and the trade cost reductions associated with similar deep trade agreements in the past, the modelling exercise assumes that the agreement reduces trade costs by an average of around 2.8 percentage points for UK exporters to Japan and 2.3 percentage points for Japanese exporters to the UK in the long run (simple average of total average tariff and non-tariff cost reductions, external CGE modelling). The modelled trade cost reductions vary markedly across goods and services sectors reflecting the historical evidence of the sectoral impacts of FTAs as well as the provisions of the UK-Japan CEPA.

In the long run, the trade costs reduced by the UK-Japan CEPA are estimated to drive an increase in UK exports to Japan by 17.2% or £2.6 billion and UK imports from Japan by 79.9% or £13 billion when compared to 2019 levels. Therefore, in the long run overall bilateral trade between the UK and Japan is estimated to increase by 50% or £15.7 billion when compared to 2019 levels.

Although UK-Japan bilateral trade is estimated to increase significantly in the long run, total UK trade with all countries (including Japan) is expected to result in a more modest increase in trade given the share of UK-Japan trade (2.2% of total UK trade) with UK exports to and UK imports from all countries (including Japan) estimated to increase by 0.58% and 0.51% respectively in the long run. Overall, in the long run total UK exports and imports to the world are expected to result in a 0.5% or £7.8 billion increase when compared to 2019 levels.

Trade is an important source of jobs for UK workers. Latest available estimates suggest that around 167,000 jobs in the UK were supported by exports to Japan in 2015 (source: Organisation for Economic Co-operation and Development Trade in Employment database, last updated: March 2019). Increases in export opportunities are an important source of growth and economies of scale for UK businesses.

UK trade with Japan is important to the UK economy as:

1. just over three quarters of UK imports from Japan are estimated to be intermediate or capital goods used in UK production (source: United Nations, Classification by Broad Economic Categories Rev.5, 2018: passenger motor vehicles have been included within the consumer goods category. Broad economic categories has limitations as a source for identifying goods for intermediate use).
2. increases in imports of intermediate goods help to drive increased business competitiveness, increase their integration in global supply chains and reduce prices.
3. increases in imports of final products could offer better quality and choice for consumers.

Reduced regulatory restrictions and increase trade in services and digital

Trade in services is important to both the UK and Japan. Services accounted for 80% of UK GDP in 2019 and 39% of the value of UK trade with the world in 2019 (source: Office for National Statistics, GDP output approach – low-level aggregates). Services exports to Japan were worth £8.0 billion in 2019, which accounts for 52% of all UK exports to Japan (source: Office for National Statistics, UK trade, quarterly trade in goods and services tables: January to March 2020).

The UK-Japan CEPA contains several chapters which aim to reduce unnecessary barriers to services trade arising from domestic regulations, including the ‘trade in services, investment, and electronic commerce’ and ‘intellectual property’.

From an economic perspective, the provisions reduce trade and investment costs for services through removing barriers and ensuring fair competition. For example, the agreement reaffirms commitments to non-discriminatory treatment of domestic and foreign businesses and removes several restrictions on businesses seeking to expand existing trade in Japan or enter the market for the first time. These include, for example, prohibiting restrictions on the number of UK service suppliers seeking to trade in Japan and removing the need for businesses to complete economic needs tests prior to establishing presence in Japan.

Several provisions reduce trade costs by providing greater certainty to service suppliers, such as through increased commitments on clarity and transparency of application and licensing procedures for service suppliers seeking to operate in each other’s countries. The agreement contains provisions on the movement of natural persons for business purposes, referred to as mode IV services trade. These provisions will help ensure that UK professionals have certainty of entering Japan through a number of routes to provide services or establish, with clearer and streamlined processing for temporary business visas.

Digital and data provisions in the UK-Japan CEPA go beyond the existing arrangements under the EU-Japan EPA to reduce costs by providing greater policy certainty for UK and Japanese service suppliers. For example, the agreement contains commitments to uphold the free flow of data. These commitments provide business the assurances they need that they can collect, process, and transfer data between the 2 countries, without facing unnecessary red tape while maintaining commitment to the UK’s Data Protection Act 2018. The free flow of data is essential in many industries and sectors to run operations smoothly.

In line with the scale of trade cost reductions associated with similar deep trade agreements in the past, the modelling exercise assumes that in the long run non-tariff costs facing services sectors are reduced by an average of 0.6 percentage points for Japanese exporters and 1.6 percentage points for UK exports, although the trade cost reductions vary markedly across services sectors.

As a result, trade in services between the UK and Japan is estimated to increase by 46% in the long run. The largest increases in exports are expected to be in Financial services, Insurance and Business services.

Increased certainty for investors

The UK and Japan have close investment ties, most notably in the UK’s automotive industry. Japan accounted for 5.9% of the total UK inward foreign direct investment (FDI) stock in 2018. Japanese data shows the UK was the 2nd largest destination for outward Japanese FDI (source: Japan External Trade Organisation, Japan’s Outward FDI 2018).

The agreement contains provisions aimed at securing the liberalisation of FDI between the UK and Japan. The agreement enables the establishment and operation of enterprises in each other’s country by committing to open market access as well as non-discriminatory treatment. The agreement ensures that UK and Japanese entrepreneurs and enterprises seeking to invest in each economy are able to do so on an equal footing via specific provisions on national treatment and most-favoured-nation treatment (Article 8.8 National Treatment and article 8.9 most-favoured-nation treatment). This means that the treatment of businesses is equal to domestic and third country businesses, which in turn underpins certainty for businesses seeking to invest. Furthermore, enterprises seeking to invest are not required to appoint individuals of any particular nationality as executives, managers or members of boards of directors (Article 8.10 Senior Management Board of Directors). Importantly, the agreement prohibits conditions on performance requirements before enterprises can invest. This includes requirements on the minimum export threshold, minimum domestic content and transfer of technology to domestic industry (Article 8.11 prohibition of performance requirements).

The modelling exercise does not explicitly model the impact of the agreement on FDI. Reflecting changes in relative rates of return and the wider impacts of the agreement, domestic business investment is estimated to increase by 0.02% in the long run (external CGE modelling).

Increased trade in goods

Trade in goods represented 61% of all UK trade and 53% of UK exports in 2019 (source: Office for National Statistics, UK trade, quarterly trade in goods and services tables: January to March 2020). Of all UK exports to Japan in 2019, 48% were goods and around 9,500 UK businesses exported goods to Japan in 2018. All nations and regions of the UK traded goods with Japan in 2019.

Several chapters of the UK-Japan CEPA contain provisions aiming to remove or reduce barriers to trade in goods. These include chapters on tariffs and rules of origin, as well as non-tariff measures, such as customs facilitation and technical barriers to trade.

The agreement substantially reduces tariffs on UK exports to Japan which can generate opportunities for UK businesses through maintaining or increasing competitiveness, particularly when compared to businesses exporting to Japan from countries without an FTA. 39% of Japan’s tariff lines are duty free. The UK-Japan CEPA liberalises a further 45% of tariff lines at entry into force, with a further 11% being liberalised in the long run. This equates to 98% of UK goods exports being liberalised at entry into force, rising to 99% in the long run. This compares to 88% of UK goods exports entering duty free in a situation where the UK and Japan do not have an agreement.

Based upon 2019 trade flows, the estimates suggest that annual duties on UK exports to Japan could reduce by £30.4 million in the short term, with a £34.9 million reduction in the long term (DIT internal analysis. Japan trade statistics portal 2019. Short term is defined as tariff savings in 2021 and long term is tariff savings from 2038 onward). The largest reductions in export duties occur in the textiles, animal and animal products and chemical products. The export opportunities are estimated to benefit all nations and regions of UK, with particular benefits for London and Scotland which account for 9% and 8% of UK goods exports to Japan respectively but, based upon the pattern of Japanese tariffs and regional exports, are estimated to benefit from 17% and 16% of overall tariff reductions on UK exports.

Annual reductions in tariffs on UK imports from Japan are estimated to be £137.1 million, with £44.7 million on imported intermediate goods and £92.5 million on consumer goods in the long term (source: DIT internal analysis. Eurostat, 2019. Short term is defined as tariff savings in 2021 and long term is tariff savings from 2038 onward). Consumers are expected to benefit most from tariff reductions on recreational goods and transport goods (such as cars), which accounted for 15% and 16% of household consumption baskets in 2018. If passed on, consumers could benefit from lower prices and increased choice.

The agreement contains substantive provisions, aimed at reducing non-tariff costs to trade, including measures which support the protection of the UK’s geographical indicators for agricultural goods such as Scottish farmed salmon and West Country farmhouse cheddar cheese and measures which support UK industry such as the commitments to apply relevant industrial standards which reduce the administrative costs associated with trading.

In line with the tariff schedules and the scale of trade cost reductions associated with similar deep trade agreements in the past, the modelling assumes tariff cost reductions in goods sectors of an average of around 2.9 percentage points for Japanese exporters and 3.3 percentage points for UK exporters. For non-tariff costs the modelling assumes an average reduction of 2.4 percentage points for Japanese exporters and 2.9 percentage points for UK goods exporters. The assumed trade cost reductions do however vary markedly across goods sectors. Under the UK-Japan CEPA, both parties have largely eliminated duties on most goods, particularly on agriculture, forestry and fishery products, and on industrial products, the former being more relevant for the UK, and the latter for Japan.

Taking these factors into account, trade in goods between the UK and Japan is estimated to increase by 53% as a result of the agreement. The largest increases in exports are expected in ‘textiles and leather’, ‘agriculture’ and ‘processed foods’.

Wider macroeconomic impacts

Trade liberalisation and increases in international trade drive improvements in growth, productivity and wages. Trade agreements are expected to drive gains through several channels, including:

• gains through increased specialisation across sectors, whereby enhanced access to international markets and imports reshapes the economy to specialise in producing goods and services in sectors which they are relatively better at producing

• gains resulting from a more efficient allocation of resources within sectors. Enhanced openness to trade can spur innovation and the expansion of the most efficient firms within sectors, driving up the average productivity and wages within the sector, while at the same time, generating increased choice and lower prices for consumers

• dynamic gains through trade-induced increases in productivity. These result from businesses benefiting from greater economies of scale or scope, increases in investment and research and development stimulated by access to larger markets, reductions in inefficiencies due to increased competition, or from positive spill overs between firms

Increases in GDP and wages

The UK-Japan CEPA is estimated to increase the UK’s long run GDP by 0.07%. Compared to UK GDP in 2019 (£2.2 trillion), this represents a £1.5 billion increase in GDP (source: external CGE analysis and Office for National Statistics, GDP at market prices: Current price: seasonally adjusted £ million). The long run is generally assumed to represent around 15 years from implementation of the agreement. The increases in GDP derive from a more efficient reallocation of resources across the economy. Higher returns to capital can increase investment and productivity, which also contribute to higher long run GDP.

The reshaping of the economy, changes in prices and long run increases in productivity drive long run increases in real wages for UK workers of around 0.09%, worth £0.8 billion when compared to 2019 levels (source: external CGE analysis Office for National Statistics, UK sector (S.1): Wages and salaries (D.11): Resources: Current price: £ million: not seasonally adjusted). From labourers to managers, all occupation types are estimated to benefit from higher wages as a result of the UK-Japan CEPA.

Distributional impacts

The impacts of the UK-Japan CEPA are estimated to vary across sectors and nations and regions of the UK.

Sectors

Most sectors are expected to increase output as a result of the UK-Japan CEPA. Output in the textiles and leather sector is expected to increase the most. This is due to assumed reductions in trade barriers combined with the UK being relatively competitive in this sector. Some sectors, such as the motor vehicles and chemicals, rubber, plastics sectors, are estimated to reduce output relative to the baseline. These are sectors where Japan is relatively competitive. It is likely that the reductions in output partly reflect a reallocation of resources (capital and labour) away from these sectors towards other sectors of the economy that expand output in response to the CEPA.

Nations and regions of the UK

All nations and regions of the UK are estimated to increase output as a result of the UK-Japan CEPA. London, the East Midlands and Scotland are expected to expand the most; the UK-Japan CEPA is estimated to increase Gross Value Added (GVA) in these regions and nations by 0.09%, 0.08% and 0.07% respectively. For context, these estimated increases equate to approximately £398 million for London, £82 million for the East Midlands and £101 million for Scotland when compared to the latest available GVA levels in 2017. The £ values should not be interpreted as estimates of the long run impact on each nation and region as the levels of GVA are likely to change substantially over the next 15 years (the ‘long run’).

Labour markets and adjustment costs

As is common practice, the modelling exercise assumes that overall employment or unemployment is unchanged by the agreement in the long run. The estimates show small changes in the distribution of workers across sectors of the economy as some sectors increase employment relative to the baseline, while employment reduces in others. The scale of adjustment is very small relative to usual levels of change observed in the labour market and is not heavily concentrated in particular sectors. The representation of protected groups (in relation to age, sex, ethnicity and disability), in sectors where employment falls relative to the baseline as a result of the UK-Japan CEPA, is estimated to be largely in line with the general population of the workforce.

Summary of impacts and next steps

The overall quantitative impacts derived from the modelling exercise summarised in the table.

Summary of long run UK macroeconomic impacts	Change on baseline
Change in GDP %	0.07%
Change in GDP £	£1.5 billion
Change in UK exports to Japan	17.20%
Change in UK imports from Japan	79.94%
Change in total UK exports	0.58%
Change in total UK imports	0.51%
Change in real wages %	0.09%
Change in real wages £	£800 million

Monitoring and evaluation (M&E) of the implementation and impacts of the UK-Japan CEPA is an important part of ensuring the benefits are maximised for businesses, workers, and consumers and that the new trade opportunities FTAs create are fully realised.

As part of a transparent approach to M&E of the implementation and impact of the UK-Japan CEPA, DIT will conduct a comprehensive ex-post evaluation for the UK-Japan CEPA.