The Chinese And Japanese Economies Are Delinking: Prelude To Conflict?

Japan issued 79,000 group tourist visas to Mainland Chinese last month.  That’s on top of more than 30,000 individual visas.  The total was ten times the number issued in January 2013.

Are cashed-up Chinese the answer to the region’s worsening geopolitical tensions?  Hong Kong’s South China Morning Postthinks they just might be.  Yesterday, the paper issued an editorial entitled “Increase in Tourism Can Help Heal Sino-Japan Rift.”

That seems like a stretch, but East Asia could use any good news these days.  China is unnerving the region as it tries, among other things, to seize neighboring territory and incorporate surrounding seas.  In late November, Beijing declared its East China Sea Air Defense Identification Zone, which infringes on accepted notions of freedom of navigation and seeks to control the airspace of Japan and South Korea.  Moreover, China issued rules, effective the first of this year, purporting to exercise sovereignty over international water in the South China Sea.  And to top that off, Chinese General Liu Yazhou at the beginning of the year publicly urged his country to engage in armed conflict to grab territory from neighbors.

No wonder the region’s leaders are beginning to talk as if war is just around the corner.  Japanese Prime Minister Shinzo Abe, while responding to a question in Davos in January, likened the present relationship between his country and China to that of England and Germany a hundred years ago.  Philippine President Benigno Aquino this month made a pointed referenceto 1938.  And today is beginning to look like 1937, when war in fact erupted in Asia.  Secretary of State John Kerry is now touring the region, hoping to restrain China and reassure allies and friends, but so far his mission does not look like a success.

Observers used to say that deep-seated disagreements in the region did not matter, that there could be “cold politics and hot economics.”  Today, analysts are not so sure.  Jitters are now accompanying—and undoubtedly contributing to—a delinking of Asia’s two largest economies, China’s and Japan’s.

In 2013, trade volume between China and Japan dropped 5.1% from the year before.  That followed a 3.9% fall in 2012.  To put these figures into context, China’s total trade was up 6.2% in 2012 and 7.6% last year while Japan’s volume increased 1.0% in 2012 but was down 7.8% in 2013.

Japanese sources attributed the drop in China-Japan trade to “the lingering effects of the Senkaku Islands territorial row”—Japan administers those barren outcroppings as its own while Beijing claims them as well—and a Chinese consumer boycott of Japanese goods.  Chinese state media agrees that trade has been adversely affected by geopolitical disagreements and blames Shinzo Abe.  Anti-Japan riots in Chinese cities, discriminatory official treatment of Japanese multinationals, and detention of Japanese businessmen in China have not helped.

Not surprisingly, investment between China and Japan has also taken a hit.  Japanese direct investment in China dropped 4.3% last year even though overall foreign direct investment in China increased 5.3%.  At the same time, China’s direct investment in Japan fell 23.5% at a time when its overall outbound investment jumped 16.8%.

The poor numbers for 2013 contrast with strong investment flows in 2012 and are largely the result of deteriorating relations.  Said Song Zhiyong of China’s Commerce Ministry, “The Chinese government attached great importance to the islands dispute and Chinese companies are concerned about the pressure and operational risks before investing in Japan.”

Song’s explanation for the falloff in Chinese investment in Japan is probably correct.  The reason for the decline in Japanese investment in China is surely a bit more complex.  Undoubtedly, rising Chinese wages—well in excess of productivity—have persuaded Japan’s labor-intensive businesses to invest in Southeast Asia instead.

That said, however, non-business risk is now a big factor.  “Political tension was the major reason for the slide in Japan’s investment in China last year,” said Yao Haitian of the Institute of Japanese Studies of the Chinese Academy of Social Sciences.  Yao predicts relations between the two countries will get worse this year.

So far, Yao’s prediction looks spot on.  In addition to everything else, CNOOC Ltd., a Chinese state-run company, is on the verge of accelerating drilling in the East China Sea for gas with the development of seven new fields.  Some of those fields are close to deposits claimed by Japan, and this will almost certainly exacerbate a decade-old maritime dispute between the two nations.

General factors will also tend to accelerate delinkage.  Beijing is still trying to undermine the business prospects of multinationals with its discriminatory price investigations, and Chinese officials will probably intensify their attempts to use economic leverage to obtain geopolitical goals, thereby aggravating the situation.  Stricter Chinese enforcement of labor and environmental laws will also have an effect on investment decisions made back in Japan.  Perhaps most important, a quickly slowing economy makes China far less attractive, especially in relation to nearby markets.

For China-Japan trade and investment to increase this year, these long-term trends would have to reverse right away.  That’s not likely.  Of course, the increase in Chinese tourism in Japan helps alleviate matters, but in the scheme of things it is not that big a factor.  As a practical matter, 2011 looks like it was the high-water mark of Chinese-Japanese economic integration.

Why does the weakening of economic linkages matter?  As Samuel Huntington noted in his landmark The Clash of Civilizations and the Remaking of World Order, “high levels of economic interdependence” can be “war-inducing” instead of “peace-inducing” if “states do not expect high levels of interdependence to continue.”

As the famous political scientist suggested, it is the trend of interaction—and not the level—that matters. When economies are pulling apart, nations perceive they have less interest in others’ success.  History, unfortunately, tells us what can then happen.