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.

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.

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.

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.