The dispute between Japan and China over the Senkaku / Diaoyu islands continues to simmer. Even as International Monetary Fund (IMF) chief Christine Lagarde warned about the dangers to the global economy should the dispute escalate, the fallout from the squabble continues to build momentum. There was always going to be a risk of economic consequences for both sides, as Japanese companies operating in China were forced to shut down operations and had property damaged during the recent flair-up in tensions. Since the protests in China have stopped, a string of reports have emerged that show the consequences are going to be very real.
The number of passengers on flights between Japan and China have plummeted, and at least one ferry route between the nations has cancelled its services due to a lack of custom. On September 19, one day after protests peaked in the China, the chairman of Japan’s Foreign Trade Council stated that China had “slowed down” its clearance of imports from Japan. On the September 27, a senior Philippine trade official announced that the country, which has its own territorial disagreements with Beijing, was in talks with fifteen Japanese firms looking to relocate manufacturing operations out of China. This week it has also emerged that one of Toyota Motors’ key tyre suppliers would be scaling back its expansion in China, stating that it could supply the Chinese market just as easily from Malaysia. On Thursday, Mazda in China announced a 35% fall in sales in September.
News emerged this week that several Chinese financial institutions, including China’s four largest banks – the Industrial and Commercial Bank of China, China Construction Bank, Bank of China and Agricultural Bank of China – had withdrawn their participation in the IMF and World Bank summits to be held in Tokyo next week. For the Bank of China, which ranks amongst the designated “global systemically important financial institutions” (G-SIFIs), limiting participation in the IMF and World Bank meetings is especially worrisome. It also emerged that three of the big four banks had withdrawn from the Swift International Banking Operations Seminar (SIBOS) to be held in Osaka later this month – not a famous gathering, but one held to be very important by finance industry insiders.
Not all of these disruptions can be slated home to the islands dispute; there are more long-term structural changes underway too. First and foremost is the expected completion of the China-ASEAN Free Trade Agreement (CAFTA) by the end of 2015. This will mean that goods shipped from the ASEAN bloc into China will face estimated average tariffs of just 0.1%. It thus makes good sense for Japanese firms to shift some of their investment to these less politically risky economies. For goods produced near Hanoi in Vietnam, for example, shipping to Chinese customers in Guangdong may be cheaper than producing in the north and central China and shipping them all the way south.
Another factor pushing Japanese investment out of China are rising wages and input costs. Japanese firms are not alone in beginning to shift production to areas with cheaper labor: Indonesia, Vietnam, Thailand and the Philippines have all benefited. To take the latter as an example, Japan’s second largest ship-builder Tsuneishi Holdings opened a shipyard in the Philippines this year; inward investment by Japan already grew by more than 30% in 2011. ASEAN states now receive nearly half of Japanese investment in Asia.
Many ASEAN states are growing as domestic markets in their own right, especially Indonesia with its large population – so the expected completion of CAFTA within a few years is the perfect solution to Japan’s problem, not only perpetual unpopularity in China, but also of rising production costs there.
Yet there are limits to how far and how fast this process can go. China is not just a manufacturing center, but increasingly a key market for sales. Japanese firms cannot afford to give up on such a market (as long as consumer boycotts do not do it for them). In addition, China has developed top-class infrastructure for logistics and shipping, letting firms that operate there plug into their regional and global supply chains. Whilst some ASEAN states are trying to close the gap, they remain a step behind their larger northern neighbor, for now.