| Abstract: | The European Union and Japan recently entered into negotiations over a bilateral free trade agreement intended to stimulate growth and create wealth. Since customs duties are already low, the success of the liberalisation process hinges on the elimination of non‐tariff barriers. The purpose of this paper is to shed light on two possible liberalisation scenarios: a less ambitious liberalisation and a comprehensive liberalisation. In contrast to classic studies, our paper builds on the modern trade literature, accounting for the dominance of intra‐industry trade in both economies and the existence of heterogeneous firms. Furthermore, we model a search‐and‐matching labour market, allowing us to quantify employment effects of trade liberalisation. We find that a comprehensive liberalisation increases Japanese GDP by 0.86 per cent, whereas the EU experiences only an additional 0.21 per cent of real GDP growth. Most of the growth in real GDP is due to firms' efficiency gains, whereas unemployment is reduced by only a small amount. Other world regions experience small reductions of GDP due to trade diversion effects. |
