Deregulation Japan-style: on the (local) grog

Author: Luke Nottage
(with thanks to Ichiro Araki)

Japan appeared to have recovered from its own financial crisis a decade ago, albeit at the cost of much accumulated government debt. The country was then hit by the collapse of its export markets and the rapid rise of the yen, following the imminent global recession.

Professor Iwao Nakatani, former Chairman of Sony, has urged a radical shift in economic policy in Japan and elsewhere from policy ‘based on neo-conservative economics and the philosophy of small government to one based on Keynesianism and welfare state ideology’.

Some may be sceptical as to whether Japan ever really embraced the former philosophy, and its ascendancy was certainly never as pronounced as in the US, the UK or then Australia.

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But deregulation of alcohol distribution is one of Japan’s many transformations over the last decade. It is also the flipside of ever-stricter rules on drink driving, although these rules also reflect a broader trend towards criminalisation of socio-economic deviance, evident in product safety or consumer credit re-regulation.

On the other hand, deregulation is most notable in terms of where you can buy alcohol to celebrate this New Year of the Ox: namely, vending machines and those ubiquitous convenience stores. It is less obvious in what you pay, especially for certain beer substitutes, which reflect differential tax rates.

In fact, these tax rates may well violate WTO law. Yet there is probably not enough financial reward for potential beer exporters to Japan to encourage their home governments to sue Japan. So an implication for FTA negotiators , even those from Australia, may be to seek some offset advantage in their overall bilateral deal with Japan, which would further undermine the entire multilateral WTO framework.

Rising numbers of visitors to Japan and other commentators have remarked on the proliferation of automatic vending machines, including those selling alcohol. Careful observers may have noticed an ID card ‘reader’ supplied with many machines since 2001. Designed mainly to check the age given on drivers’ licences, the readers were partly a response to stricter punishments introduced for liquor store owners selling alcohol to minors. They were also intended to claw back market share for ‘mom and pop’ stores. Such stores’ share had dropped from 76 per cent in 1983 to 27 per cent by 2000. The big winners of increasing licensing liberalisation had been larger discount outlets and especially convenience stores, particularly after rule changes in 1993, 1998 and 2003.

By last year, at least in Kyoto, many remaining stores seemed to have rendered the readers inoperable, as the above photo shows. One store owner just told me that they led to too large a drop in sales!

The local police don’t seem too concerned, now that alcohol is available in so many convenience stores 24/7, although things are reportedly different in parts of Osaka where teenage drinking remains a social problem.

This seems a victory for the proponents of deregulation, despite opposition from many LDP parliamentarians and their small business constituents, although some health and consumer interest advocates are concerned as well. But this industry turns out to be more complicated.

Of Japan’s large alcohol market, sake (rice wine), shochu (distilled spirits), and dai-san biiru (‘third-category’ beer) each make up about 10 per cent, followed by around 20 per centfor happoshu and 40 per cent for (real) beer. The latter must have a malt content of at least 67 per cent, but is the most heavily taxed.

In 1994, Suntory began marketing beer-like happoshu with malt content of 65 per cent, while Sapporo developed happoshu containing less than 25 per cent malt. Each attracted lower tax rates, and hence could be sold much more cheaply than real beer.

From 1996, however, the government responded by hiking the tax rates for both types of happoshu. In 2003, it also raised tax on happoshu with 25-50 per cent malt content. However, its tax and that of happoshu with less than 25 per cent malt remained less than that on high-malt happoshu or real beer. In 2004, Sapporo and Suntory responded with a zero-malt dai-san biiru, which incurred an even lower tax, and hence retail price, than any happoshu.

In 2002, the then Director of Research at RIETI (a METI offshoot), argued that Japan’s existing tax differentials between happoshu and real beer amounted to tax discrimination between ‘like products’, contrary to WTO rules:

‘Article III:2 of the General Agreement on Tariffs and Trade says: “The products of the territory of any Member imported into the territory of any other Member shall not be subject, directly or indirectly, to internal taxes or any other internal charges of any kind in excess of those applied, directly or indirectly, to like domestic products.” There is no question that beer and happoshu are like products. To the extent that imported beer is subject to tax in excess of those applied to domestically produced happoshu, it is inconsistent with the WTO rules. …

The tax authorities are right in their move to equalize the level of taxation between beer and happoshu. The major breweries opposed to this are wrong. Their argument that happoshu is a totally new product might have been more persuasive if there had been a net increase in the combined market of beer and happoshu, but in reality, happoshu merely substituted some of the beer market. Beer and happoshu should be taxed equally. Of course, the tax authorities could decide to lower the tax rate on beer to the level equal to happoshu, but such a decision is extremely unlikely in view of the current budget crisis.’

Happoshu tax rates were indeed raised from 2003, but some differentials remain. Other commentary and cases in the WTO (against Korean soju, 1997-9; and Chilean pisco, 1998-2000) suggest that key tests for discrimination among ‘like products’ include their physical characteristics, common end-uses, tariff classifications, and ‘the marketplace’, possibly including evidence from changes in other countries.

So Professor Ichiro Araki’s argument in 2002 still seems valid for at least some types of happoshu – and possibly even now dai-san biiru. And that would suggest some persistent limits to liberalising parts of the alcohol industry in Japan, especially when foreign imports, actual or potential, are involved.

Yet which country and their exporters are really likely to sue Japan?

Possibly, low-cost producers of reasonable beer from nearby countries, such as China (Tsingtao Beer), Thailand (Singha), Singapore (Tiger) – and perhaps even Mexico (Corona) or Australia. But China didn’t accede to the WTO until 2001, and Japanese consumers have gone off Chinese food imports, especially after last year.

Singapore, then Thailand and Mexico, now Australia, wouldn’t want to jeopardise FTAs with Japan by launching a WTO complaint over an issue like this. And the situation is further complicated by Japanese brewers investing overseas, especially Kirin, in brewer Lion Nathan, and more recently Asahi, in Cadbury Schweppes in Australia.

So perhaps all that might be achieved in dealing with these problems in Japan, especially by countries (like Australia) still negotiating an FTA, is through raising the issue to achieve some sort of extra advantage in the overall bilateral deal. Any advantage could be small, given the practicalities of suing (or not). Some questions also remain about applying the substantive legal test in the context of a product like beer rather than spirits. And such bilateral negotiations in any case undermine a transparent multilateral system of international trade law.

Further reading:
For a longer version with statistics, see the Japanese Law and the Asia-Pacific blog.
Also, the Telegraph bases Legal trouble brewing for Japan’s low-tax beer on this article.

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