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.

1. The discussion of the concept of 'distance' in this report draws on the work of Ghemawat (2007).