While the world’s eyes have been focused on Russia’s aggression in Ukraine, the political and economic playing field has been heating up across East Asia. China and Japan, the world’s second and third largest economies, respectively, – are heading towards more hostile relations, and the ripple effects of this are trickling down both in Asia as well as on global markets.
Trading friends, regional foes.
During the post war period, the US was Japan’s main trading partner and also its main security guarantor. Hence, the interconnection of geoeconomics and security has been a key policy aspect for Tokyo. With China’s opening up and integration in the global trading system when it joined the World Trade Organization (WTO) in 2001, the world’s geo-economic environment has rapidly transformed. Japanese multinational enterprises that were early to take advantage of globalization by creating complex production networks saw new possibilities in China. Indeed, Japanese companies could take advantage of cost and market access and rapidly increased their industrial footprint. In parallel, Chinese companies developed across a number of sectors, growing their ability to challenge not only Japanese firms, but also other established Western MNEs.
This new environment has generated a profound change to Japan’s economic and security positioning.
First, China has risen to become Japan’s most important trading partner. With its traditional adversary becoming its most important trade partner come changes to Japan’s security policies. To be sure , Japan has continued to enhance its military industrial collaboration with the US in order to counter China’s influence in the region. If the region’s security landscape was to deteriorate, however, it is likely that Washington would engage more in industries with a connection to the military and security sectors. Second, the increase of Japanese foreign direct investment to China has also made the two economies more interconnected. This, in turn, generates technological knowledge transfer, capital, and employment, with Japan’s increasing investments towards China at the expense of investments in production networks in Southeast Asia. Nonetheless, these investment flows have been much larger in relation to Japan’s outwards investments to China than those going in the opposite direction. This gives an indication of China’s relative importance as a production location and market for Japanese firms. Third, Chinese multinationals have eyed investments in Japan to buy their spots in established brands across electronics or white goods. This can be seen as an example of the ongoing business reinvention of corporate Japan, where firms are striving to develop value at the high end of value chains, often at the intersection between advanced manufacturing and service content.
A one-sided relationship
The last four decades of increased economic interdependence between Japan and China have led to a balancing act of economics and politics. During the first decade of the 2000s, controversies around the Senkakau Islands and visits to the controversial Yasukuni shrine in downtown Tokyo, led to diplomatic tensions between Japan and China. Both governments realized that the potential economic outfall of an escalating conflict could become very consequential. Now, the stakes have once again risen with Beijing’s growing political and economic ambitions.
The relation’s relative power has also changed over the past 10 to 15 years. China has become more important for Japan in terms of trade, although not the other way round. China has expanded into other directions, and has thus also increased its military and security goals. Japanese companies, in turn, have diversified their production to other locations in order not to be too exposed to China. This has also caused the Japanese government to support such practices in order to balance the country’s economic and trade exposure to China. Despite these complex political dynamics, it seems that both countries have been able to sustain a situation that has proven to be working for geo-economic ties thus far, both on the macroeconomic level as well as for companies conducting businesses in both directions. However, recent security developments across East Asia have put a strain on Tokyo and Beijing’s relation.
Nothing ventured, nothing gained.
Increased tensions over Taiwan in the aftermath of US Speaker of the House, Nancy Pelosi’s visit to the island have shed a light on current geo-economic and geopolitical relations between Japan and China. With its strong commitment towards sanctions against Russia and the belief in what is referred to as the “rule-based world order”, Tokyo has clearly taken a position to counter threats from both Moscow and Beijing in its neighborhood. As such, what are the geo-economic and geopolitical implications of Japan’s current position? In the short term, deteriorating relations between Japan and China could possibly be more severe for the former. This is due to the fact that trade and investments would suffer, and that value chains and complex regional production networks would take time to adjust if tensions increased and China turned to economic retaliation. Intermediate goods and resources such as rare earth metals, which play a significant role in trade, could lead to shortages. This potential impact on trade could have a negative effect on Japan’s economic growth , though the repercussions would ultimately wane off.
In the medium term, Japanese companies would seize upon a more diversified industrial footprint offered by East and Southeast Asia. A potential key component here is the relatively recent Regional Comprehensive Economic Partnership (RCEP), a free trade agreement, that could enhance further economic integration between Japan and the Association of Southeast Asian Nations (ASEAN). In the long term, the severing of economic ties with Beijing could put the Chinese economy at a disadvantage. Sustaining economic growth through trade and investments has been one of China’s core growth policies. With the Western economies standing united in their sanctions against Russia, it is likely that any attempts by Beijing to engage in military actions against Taiwan would rapidly demote its its role as the world’s “workshop”, which would then have further repercussions on China’s economic ties with Japan.