The Chinese Communist Party’s 18^th National Congress is one of the most important political events of the year, beginning a turnover in Party (and ultimately state) leadership. In addition to the leadership transition, the National Congress will define the party line in all major policy sectors, including foreign and defense policy. It is an excellent opportunity for Chinese leaders to turn the current disastrous Japan policy around before it’s too late.

The recent tensions between China and Japan over disputed islands in the East China Sea continue to simmer after the Japanese government purchased the islands from a private owner in mid-September. Following the purchase, nationalists from both Japan and Taiwan made publicity landings on the islands, revealing the extent that nationalism on both sides has hijacked the issue from political leadership. While order has been restored, extreme views of the dispute are beginning to prevail in the media of both China and Japan. It is no longer a question whether a new crisis will take place over the islands, but when.

While Beijing and Tokyo are said to be renewing talks over the disputed territory, the islands will continue to bedevil relations unless both China and Japan reset their policies with regard to each other. While Japan has an unfortunate sense of timing (purchase of the islands coincided with the anniversary of the Marco Polo Bridge Incident), China has also encouraged anti-Japanese sentiment in its school texts and (war) history museums. The gravest sin of Chinese policy toward Japan however seems to be a growing perception in Beijing that ‘Japan doesn’t matter’ and that China can get on without Japan. This erroneous perception weakens the Chinese leadership in the region and at home.

The most important bilateral relationship in the Asia Pacific is thought to be that between the U.S. and China. While that is true, a second bilateral of great importance to the Asia-Pacific – the Japan-China relationship — gets far less attention than it deserves. This bilateral has long been a bellwether for any Asian order, and is important for both medium- and long-term reasons. Medium-term trends show Chinese growth slowing, with double-digit growth slowing to around 7-7.5 percent. There are signs that the next Congress will push for reforms of the state-owned enterprises sector, encouraging instead a larger private sector, and overhaul local government finances. This will require regulatory framework, which returns ebbing confidence of foreign investors on a host of areas such intellectual property and impartial legal process in law. To carry out these reforms, China will need massive flows of foreign direct investment, particularly to its’ banking and manufacturing sectors.

For this, China needs Japan and Japanese investment badly.  More than 20,000 Japanese companies ranging from apparel, electronics, and the auto industry have operations in China, with an annual turnover of $345 billion. Now, that could be at risk. According to a Reuters poll taken in Tokyo in September, more than 37 percent of Japanese companies have expressed caution about future operations on the mainland, and suggested redirecting investment to Southeast or South Asia. This would not be good. The global economy needs Chinese reforms, just as the Chinese economy needs Japanese investment. 

And this financial debate is overlaid by the long-term great power cultural and military rivalry between the two powers. While both countries remain wedded to the modern liberal rules-based order, memories are short, and the possibilities for miscalculation ever-present. For all the talk of China’s defense modernization,  Japan’s defense budget is the world’s sixth largest and it has one of the region’s largest navies.

But Beijing needs Japan much more than it realizes. Declining or not, Japan is still big. It has the world’s third largest economy, and is the second largest holder of US treasury bonds. It has a large impact on global commodities and energy: it is the largest importer of liquid natural gas (LNG) and third largest importer of crude oil. Despite its financial troubles, it still carries considerable weight in financial global institutions like the IMF, the World Bank, and the World Trade Organization.Then there are Japanese activities in the Chinese market itself: in 2011, Tokyo invested $6.3 billion of operations on the mainland (while the U.S. only invested $3 billion that same year). Japan is said to have provided more than $45 billion in development loans to China since the 1970s.  China simply cannot afford to use Japan as a foil for its nationalism and domestic security.

Allowing national sentiment to rule foreign policy has hurt Beijing’s own ambitions. By encouraging or allowing nationalism at home, China’s regional policies alienate and isolate it from the very regional powers that it needs to renew its economy and develop its place as a power in the region. One result, as has been seen, is the shift of China’s neighbors from open engagement to cautious hedging. Worryingly still, Chinese policy-makers continue to see negative regional reactions to its growing Chinese assertiveness as part of a grand U.S. containment strategy. At one conference (governed by Chatham House rules), a senior Chinese scholar noted that in the China-Philippines dispute, it was clear that the U.S. was ‘leading from behind’, a grotesque inversion of political realities and a belittling of Philippine autonomy and decision-making.  What is worrying is that China is not only blind to its negative impact on Japan and other regional powers, but it believes the responsibility for that lies elsewhere. As long as this situation continues, then no matter what the delegates at the Party Congress decide in November, the future will look less rosier than it is now. 

John Hemmings is a non-resident fellow at the Center for Strategic and International Studies: PACNET.