Strong trade and investment ties between Japan and China are key to the strategic interests of both countries. A positive sign on this front is that the Japan-China economic relationship appears to be relatively stable for the time being. But ongoing political tensions between the two states threaten cooperation in this area. To ensure long-term stability and sustainable development, Japan and China should keep politics out of business.

Economic Ties and Political Tensions

The relationship between China and Japan has long been riddled with both political and economic tensions. But until recently, Japanese officials saw multiple signs of a gradual recovery in the bilateral relationship, particularly between Japanese investors and provincial officials in China. 

The observed warming of relations started with a business dialogue in 2013. Executives from Chinese regional governments, such as Guangzhou, visited Japan’s key industries, while Japanese companies conducted trade shows in Chinese cities like Dalian and Chengdu. Meetings between key executives from Japanese companies, such as Toyota, and Chinese government executives also went smoothly. 

Such cooperation comes with a number of benefits. There are multiple areas in which economic cooperation can build a strong “win-win” dynamic between China and Japan to help address the expected social and economic challenges in both countries. Indeed, the two need one another more than their current national leaders indicate. 

However, it is becoming increasingly clear that to maintain strategically important bilateral economic ties, nonpolitical bonds must be forged and fostered. 

With tensions high, official diplomatic relations are often at risk of being shut down. A recent spike in tensions came in November 2013, when the Chinese government declared an air defense identification zone over the East China Sea, where China and Japan have overlapping territorial claims. The move shocked many key Japanese policymakers and risked a broader backlash from the Japanese public. 

These types of actions can spread from the political to the economic realm as well. If tensions escalated significantly enough, Japan could take steps to reduce its investment in China. In China, there is a risk of vandalism of Japanese stores, boycotts of Japanese goods, and the imposition of export restrictions. 

In the near future, the two countries should ensure that political tensions do not negatively impact their economic relationship. China and Japan should continue engaging each other and should clearly define their long-term mutual strategic interests, especially in economic terms. 

Investing in China Helps Japan

To date, despite political tensions between China and Japan over territorial issues, Japanese investment in China has not significantly slowed down. And in the long term, Japan will need China as a source of private-sector growth. 

Spurred by the new policies of Prime Minister Shinzo Abe’s administration, Japan’s economy is showing signs of concrete growth. Yet, Japan’s economy is not robust enough to support long-term, sustainable growth. The domestic market has long been stagnant, and the Japanese population is shrinking, which will lead to a decrease in both the country’s overall consumption and the size of its workforce. 

Currently, exports and overseas investment are central pillars of Japan’s economic growth strategy. To continue to fuel growth, the Japanese private sector needs to turn toward emerging markets to provide diversified opportunities for trade and investment.
 
The Japanese private sector remains interested in investing in the still-growing Chinese economy despite the difficult political climate. For Japanese corporations, China is the second-most-promising market for long-term business development, according to a recent survey by the Japan Bank for International Cooperation. A survey by the Development Bank of Japan revealed that over 70 percent of large Japanese manufacturing companies (with more than 1 billion Japanese yen or approximately $9.7 million in capital) do not intend to slow their pace of investment in China. Recent statistics from Japan’s Ministry of Finance also demonstrate that Japanese corporations’ pace of direct investment in China is remaining relatively constant at close to $10 billion annually, as of this writing.  

Japanese investment in China is of strategic importance for Tokyo because Chinese economic health impacts Japan’s own economic development. A robust Chinese economy provides a robust market for Japanese exports and investment opportunities for Japanese businesses. And these economic activities help stimulate the global economy, which opens up even more investment opportunities for Japanese investors internationally.

But Japanese companies are also diversifying their investments. Japanese investment activities are gradually moving away from manufacturing that requires the simple assembly of products and toward investments in the production of consumer products and in expanding operations in the service sector. As Chinese consumers become better-off and have more money to spend, Japan is increasingly looking to sell those goods and services to the Chinese market. 

Japanese investors are also concerned that China’s economic growth is slowing, Chinese labor costs are rising, and the population is expected to shrink, trends that make the investment climate less desirable. China’s emerging competitors are becoming appealing investment destinations. Competitors, such as some ASEAN countries, are now attracting foreign direct investment on a large scale thanks to their low cost of labor, reliable infrastructure, and favorable tax conditions. In the past, China had a clear advantage in these areas, but that is no longer always the case.

Still, given the relatively consistent levels of investment despite the ups and downs of the relationship, it appears that in terms of the level of engagement, the commitment of Japan’s business leaders to China is far stronger than that of Japan’s political leaders. 

Why Japanese Investment Is Good for China

The Japan-China economic relationship is beneficial to both sides. China needs foreign direct investment to ensure its own consistent and sustainable economic growth. This investment can help accelerate the pace of economic reform and foster a more productive and efficient Chinese economy, which are goals of the economic policies of China’s President Xi Jinping. China must attract both investment and technology transfers to continue improving its national productivity and avoid falling into the middle-income trap. 

The economic relationship with Japan furthers China’s domestic objectives. For instance, investment from Japan in China’s economy generates employment opportunities for Chinese citizens and improves labor productivity—which is important given the rise in the cost of labor in China. Maintaining a stable economic relationship with Japan also ensures that China has access to Japanese technology that it needs to improve its domestic system. In addition, Japanese investment will help ensure that China has the stability and the funds to address pressing issues, such as the problem of air pollution and other sources of environmental degradation. 

Japanese investment can eventually help foster sustainable economic growth in China, which will provide Beijing the time to prepare for a future in which its economic growth slows due to the aging of its own population. China will need the resources and the expertise, both of which Japan can offer, to build a sustainable social security system that can provide for its current working-age population. All this can help stabilize Chinese society, which is in the strategic interest of China’s national-level leaders. 

The problem is that if China and Japan cannot successfully keep politics separate from business, Japanese companies will accelerate the diversification of their investments away from China. And once foreign investments are transferred away from China, it will be very challenging to entice investors to return. 

Moreover, Japan’s actions can have ripple effects. The behavior of the Japanese private sector in response to the Chinese government’s actions is closely watched by multinational firms that are not from Japan to determine possible risks of operating businesses in China.

Conclusion

Both Japanese and Chinese national leaders should recognize that separating business from politics can further their own strategic interests in bringing sustained economic growth to their countries. With political tensions ongoing, the two countries should develop and maintain alternative, multilayered channels of communication to secure the bilateral economic relationship. 

Taking a long-term perspective, the two sides could begin by encouraging dialogue between promising young Chinese and Japanese leaders in their thirties or forties. These actors have fewer stakes in the current bilateral relationship. The groups can include not only businesspeople but also voices from the fields of science, the arts, education, the media, and more. 

Such a step will help promote a mutual understanding of the two countries’ future strategic visions and interests. Currently, opportunities for this kind of dialogue are very limited, especially for younger generations, so this would be a significant improvement even in the short term. 

National-level leaders in both China and Japan should not forget that current tensions will affect the future generations for which they are responsible. Defining areas of mutual strategic interest and pursuing cooperation in those realms, whatever happens in the political sphere, will help build a sustainable future. 

Hiroaki Kuwajima is the chief financial officer at Aoyama Shachu Corporation. The views expressed in this publication are those of the author and do not necessarily reflect the policy or position of Aoyama Shachu Corporation or any organization with which the author is affiliated.