Why Brexit is a big deal for Japan

Head of Advisory at Asia House, Ed Ratcliffe, analyses how Brexit could impact on Japan-UK trade and investment.

With some £46 billion of investment in the UK, Japan is one of the most exposed to the UK economy and the risk of a no-deal Brexit. Hence Prime Minister Abe’s support for Theresa May’s deal during their recent press conference at Number 10. “We truly hope that a no-deal Brexit will be avoided,” he said. “In fact, that is the whole wish of the whole world.”

Abe’s earnestness is understandable. Unlike other Asian investors such as China, whose investments are more focused on the UK domestic economy, several high-profile Japanese investments could be seriously affected by Brexit and the disruption to cross-border trade.

Japan’s investment in the UK

Japanese investment in the UK has a long political history. British governments since the Thatcher era have encouraged Japanese investment by promoting the UK as a stable and business-friendly nation. Japan is the UK’s biggest source of investment from Asia, and the UK is Japan’s second biggest destination for investment, following only the US. There are more than 1,300 Japanese companies in the UK, which employ approximately 140,000 people.

The most notable examples are in the auto industry, where together Nissan, Honda and Toyota produce half of all cars made in the UK –  more than 835,000 cars per year; Nissan alone produces 500,000 of these. More than half of the cars produced in the UK are exported to the EU.

The automotive sector is an area where economic and political interests collide. Business Secretary Greg Clarke sent a letter to Nissan in 2016 maintaining that the UK would remain competitive after Brexit and giving further assurances of an advantageous business environment. Nissan took the bait and committed to producing two new car models in the UK, an effective stamp of approval for the post-Brexit environment and a coup for the Brexiteers. Given the need for access to European consumers, and the reliance on a just-in-time supply chain, this may be a commitment that Nissan shifts into reverse in the event of no-deal.

There is also a significant Japanese presence in other industries. Softbank acquired UK-based chip manufacturer Arm Holdings for £24 billion in 2016 and has continued to invest in the company adding more than 2,000 employees, including 500 in the UK. Japanese telco giant KDDI made significant investments in its subsidiary Telehouse which manages around 70 percent of London’s internet traffic. Other investments have been made across financial services, energy, electronics, information technology, pharmaceuticals, insurance, research and education, media and hospitality.

This makes the prospect of domestic economic disruption and changes to trade relations with Europe a high stakes game for the UK and Japan; but one where Japan is not at the table.

Brexit effect

According to a statement released by the Japanese Ministry of Foreign Affairs in 2016, the most undesirable effect of Brexit would be unpredictability; that the results of the negotiations would not be clear until the last minute. Unfortunately, this is exactly the scenario Japanese businesses find themselves in, along with everyone else.

Continued uncertainty – whether a possible extension of Article 50, the potential for a People’s Vote, or the ongoing negotiation of the trading relationship – remains a major concern. A no-deal Brexit would affect Japanese companies by hindering freedom of movement of goods and services between the UK and the EU. It most obviously impacts the automotive, pharmaceutical, and other high-tech industries which trade across borders multiple times throughout the manufacturing cycle. No-deal would create new financial, regulatory and practical barriers to the free flow of goods to the EU, which was a decisive element of many Japanese companies’ decision to invest in the UK.

In financial services, UK-based Japanese banks will also lose the coveted ‘passporting rights’ to sell services within in the EU. Japanese bank Norinchukin, one of the 40 largest banks in the world, has already announced a move to set up a wholly owned subsidiary in Amsterdam. The bank announced the decision was driven by Brexit, as well as other changes to the European economic environment. Among other smaller media firms, Sony will be joining Norinchukin in Amsterdam, as it moves its European headquarters out of the UK to avoid the Brexit disruption.

Not known for being outspoken, Japanese businesses have been clear about their views on Brexit. Hiroaki Nakanishi, Chairman of the most powerful Japanese business lobby, Keidanren, who is also chairman of Hitachi, a major UK investor, has said a no-deal Brexit would be disastrous.

Japanese businesses are in the same boat as many large UK, European or other international businesses based in the UK who do not rely on the UK domestic market. These businesses are looking for certainty in the short-term, and a close relationship that removes as many frictions to trade and retains as many rights as possible.

UK impact – an FTA in force next year?

For the UK, there could be significant implications. The most potent is the potential job losses and the largescale withdrawal of investment from Japan. A slumping pound sterling may in this case be a blessing as it would make asset sales a less attractive option and possibly attract FDI if the UK economy looked relatively healthy and stable.

But there is another factor that will be causing concern in terms of lost opportunity – the recently-agreed EU-Japan free trade agreement. It is the largest bilateral trade deal ever negotiated by the EU, which covers a third of the world’s economy. Overall the deal is expected to increase exports of goods and services by 13 percent, a benefit the UK will miss out on. Trading with Japan without an FTA involves high customs taxes on many goods as well as some tricky regulatory rules related to licensing, labelling and restricted goods.

The UK exports £9.9 billion a year to Japan and some of the biggest earners – power generation equipment, vehicles, machinery, pharmaceuticals, finance, insurance and tourism – would have benefited greatly from the deal. UK imports around $13.7 billion a year from Japan, making the UK the tenth largest trading partner globally, and second largest European trading partner after Germany.

In perhaps the most notable announcement made by Abe and May, they committed to a UK-Japan FTA to be in force by December 2020. Somewhat buried in a DIT press release, the announcement suggests a future UK-Japan FTA that looks very similar to that of Japan and the EU.

Implementing such a wide-ranging deal in under two years is highly ambitious, especially considering the five years taken to negotiate the Japan-EU deal was a reasonably average time-frame. When the UK exits the EU, and if it is able to negotiate new trade deals, it is also likely to be exceptionally distracted with internal politics and the revised relationship with the EU, as it has been during the negotiating process.

Nevertheless, the need to secure new trade deals post-Brexit could spur on the UK to work hard at this new deal. Japan has been one of the most proactive supporters of open free trade, pushing both the CPTPP as well as the rules based global trading system in general. Its desire to secure more free trade deals and continue establishing itself as a leader of free trade globally could work in the UK’s favour.

Asia House Advisory helps organisations understand new operating environments and meet business-critical challenges. Find out more at asiahouse.org/advisory