Sino–Japanese economic embrace is warm enough to thaw the politics

Volume 3, no. 9, September 2015

Author: Shiro Armstrong, ANU

China and Japan are locked into each other economically. The bilateral relationship is the third-largest in the world, with a US$340 billion trade relationship in 2014. China is Japan’s largest trading partner, accounting for one-fifth of its trade, and Japan is China’s second-largest. Japan is the largest investor in China, with a stock of direct investment at more than US$100 billion in 2014 or US$30 billion more than the next largest source, the United States. But even those massive trade and investment figures do not demonstrate just how intertwined the two Asian giants are.

The importance of the Japan–China relationship is beyond bilateral. It is embedded in a deeply integrated region where supply chains and thick trade and investment flows with third countries mean that there is another dimension to the interdependence. Much of Japanese investment in Southeast Asia relies on assembly and, increasingly, value add, in China. Interdependence in the region has been achieved despite the lag in political relations. Past political enmity and unresolved history comes a distant second to the interest of prosperity.

The importance of the Japan–China relationship is beyond bilateral.

Japanese manufacturing has had to shift offshore to remain competitive in the wake of the rapid yen appreciation in the 1980s and the stagnant domestic economy and shrinking population later in the 2000s. Much of that capacity went to China, but Japan also invested in other nearby countries like Vietnam. This gave birth to the often quoted ‘China plus one’ investment strategy. Some thought that this was a response to the risk of over-exposure in China specifically, but it was simply a normal risk diversification strategy.

Disruptions to trade are costly, though supply and procurement of goods are done at arms-length and alternatives can be found when necessary. But investment involves closer and more intimate economic relations than trade, with the setting up of factories or businesses in the host country involving sinking large capital expenditures, hiring local labour and developing business and consumer relationships in the foreign environment.

The US$100 billion investment from Japan has brought jobs, technology, know-how and capital to China. Growth in that investment is slowing due to rising labour costs, but investment into higher value-added manufacturing and services is becoming more important. Chinese investment into Japan is in its infancy, with a stock of close to US$600 million in 2014, yet it is growing rapidly from a low base of just US$90 million a decade earlier. Much of this is in commercial real estate, but Chinese investment there is also seeking to acquire technology and Japanese know-how. Japan’s technological prowess is indispensable as China continues to climb the value ladder towards a high-income country.

Japan’s technological prowess is indispensable as China continues to climb the value ladder towards a high-income country.

People-to-people ties are strong, have a long history and provide ballast to the relationship. That is unsurprising given geographic and cultural proximity, but it is often underappreciated. More than half of all 184,000 international students currently in Japan are Chinese, with the proportion averaging 60 per cent over the past decade. China is the second-largest destination for Japanese students studying abroad, after the United States. Japanese students are the third-largest cohort of foreign students in China. And 2.4 million Chinese tourists visited Japan in 2014, with another 5 million waiting for visas. Yet polls in both countries report a very high proportion of citizens with unfavourable views of the other country.

China and Japan have achieved this level of economic interdependence despite the political mistrust, unresolved history and politically-turbulent relationship. Often characterised by the soubriquet ‘hot economics and cold politics’, the strong economic ties and awkward politics are not mutually exclusive. So far the cold politics have not disrupted or damaged the economic relationship to any significant degree, and the hot economics seems to have constrained the cold politics.

Relations have been at a low point recently, but trade and investment have kept up. Earlier on, during former Japanese prime minister Junichiro Koizumi’s leadership in 2001–06, relations were also at a low, with leadership visits suspended and large-scale anti-Japan protests in China in 2005. Yet the economic relationship was going gangbusters, with trade growing rapidly from US$85 billion in 2000 to US$211 billion by 2006.

Relations have been at a low point recently, but trade and investment have kept up.

When Shinzo Abe entered office for the first time in 2006, his first state visit was to China to ‘break the ice’. China probably wasn’t Abe’s first choice, but repairing the relationship was a top priority and a policy he had campaigned on. It was the importance of the economic relationship that drove the political imperative. Subsequent state visits helped thaw and melt the ice.

In China, the official mood towards Japan improved and there were no protests until relations hit rock bottom after the Senkaku/Diaoyu islands flare-up in 2012. In Japan, no leader visited Yasukuni until Abe did so in 2013, when relations were already at a low point and his domestic popularity high. But even in bad times things did not get out of control. There is too much at stake.

After an icy meeting between Chinese President Xi Jinping and Abe at APEC in November 2014, the two leaders had a warmer meeting in April 2015 in Jakarta on the sidelines of the Asian–African Conference. Xi appeared before a Japanese delegation in May 2015, receiving a letter from Abe and also announcing his intentions to improve relations. The ongoing China–Japan–Korea Summit will be another chance for Abe and Xi to meet and develop trust.

Things are looking up again for political relations, encouraged on both sides by overwhelming common economic interests.

About the author

Shiro Armstrong is an economist and Fellow at the Crawford School of Public Policy. He is Co-Director of the Australia-Japan Research Centre, Editor of the East Asia Forum, Director of the East Asian Bureau of Economic Research and Research Associate at the Center on Japanese Economy and Business at the Columbia Business School.

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