Business and Finance

The Geo-Economic Potential of the China–Japan Relationship

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This article was originally published by the East Asia Forum on 28 September, 2015.

China and Japan already together account for more than a fifth of global output, bigger than the share held by the United States or that of Europe. Over three-quarters of that, of course, is generated in mainland China but, contrary to widely held perceptions, the China–Japan economic partnership is one of the biggest in the world.

The bilateral trade 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 understate just how intertwined are these two Asian giants.

The two economies are deeply complementary, with different levels of industrial and technological capability that generate business and investment on a scale not matched in any of China’s other economic relationships, even that with the United States. Looking forward, with the shift to clean industrial technologies a top priority and Japan a natural partner in developing the new model of Chinese growth, the geo-economic potential of the economic relationship is enormous.

Yet the headlines about the China–Japan relationship are captured neither by its established scale nor by its geo-economic potential. Rather, political tensions and security rivalry dominate the headlines and frame a conception of the relationship that bedevils constructive, realistic thinking about its future. While huge trade and investment ties fuel the economies of both China and Japan, and the wider Asian region, their leaderships steadfastly look backwards to the unhappy periods in their history, not forward to the bright future that their economic development and their geo-economic circumstance has thrust upon them.

Can their economic relationship alleviate the tensions and the rivalry between China and Japan? Or will the political and security tensions between them inevitably lead to conflict in Asia? What will it take for China and Japan to negotiate a mutually acceptable regional order?

These are the questions with which the new issue of East Asia Forum Quarterly, edited by Amy King and Shiro Armstrong, deals. On the 70th anniversary of the end of World War II, the China–Japan relationship is still mired in tensions over the remembered history of Japanese war and imperialism, maritime disputes in the East China Sea and contested views about Asia’s future strategic order. Yet Chinese President Xi Jinping and Japanese Prime Minister Abe Shinzo have also used backchannel diplomacy and two face-to-face meetings to lift the relationship from its nadir in 2012–13. Even more important are the trade, investment and growing people-to-people ties that serve as ballast in the relationship.

In our lead essay this week, Shiro Armstrong points out that the importance of the Japan–China relationship extends well beyond the 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’, he says. ‘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’.

Yet the relationship is now also at an economic crossroads. Japan can no longer invest in China as a low-cost manufacturing base, as China shifts towards higher value added manufacturing and services. Japan, like South Korea, will need to become a player in China’s technological transformation at a higher level. A deeper economic relationship will demand political confidence at the top political levels in the national schemes of industrial modernisation that strive to upgrade China’s innovative and technological capacity and ameliorate the impact of industrial activity on the environment. The Japanese experience of growing out of air pollution that was as bad as China’s is today and cleaning up growth with technology has much to offer China. Japan, South Korea and China together represent a powerful engine that can drive these changes. By some measures, they represent one of the densest hubs for technological innovation anywhere in the world, with largescale generation of new patents.

Strategically, Japan has to choose whether to remain dependent on the United States and resist China’s rise to dominance of the regional order, or negotiate alternative relationships with China and the United States that seek to make Japan feel secure. Equally, China must decide where Japan fits in its own vision of regional order and find a productive way to relate to Japan, recognising that insecurity in relations will thwart China’s efforts for regional leadership.

Two experts from China and Japan, Ryo Sahashi and Daojiong Zha offer their perspectives on what is needed to fix the relationship. Sahashi argues that Japan–China cooperation could soften US anxiety about China’s growing and constructive role in regional affairs, facilitating Chinese participation in the international order. Zha argues that China should embrace Japan’s role in trilateral geo-economic cooperation.

As Armstrong concludes, so far the cold politics between China and Japan have not undermined the economic relationship to any significant degree. The hot economics seems to have restrained the cold politics. Indeed, following the frosty meeting between Xi 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 declaring his intentions to improve relations. Resumption of the China–Japan–South Korea Summit meetings will provide another chance for Abe and Xi to meet and develop trust.Opening bilateral dialogue at the top on the possibility of Japanese participation in the China-led Asian Infrastructure Investment Bank could be a useful door-opener.

But things will really look up for political relations when both sides can discover anew the shared potential of their geo-economic destiny.

Peter Drysdale is Editor of the East Asia Forum.

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