Japan and China: The Geo-Economic Dimension

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Japan and China: The Geo-Economic Dimension

The stage is set for a growing geo-economic rivalry in Asia.

Japan and China: The Geo-Economic Dimension
Credit: REUTERS/Kim Kyung-Hoon

There was a time in the not too distant past when the realm of economics and geopolitics were mutually exclusive domains in Asia. Despite historical baggage and geopolitical rivalries among regional powers, economic integration and inter-dependence went from strength to strength as the end of the Cold War removed ideological constraints on economic interactions.

Nowhere was this more evident than in the Sino-Japanese relationship, where despite historical animosities rooted in the legacy of the Second World War, bilateral trade and investment relations flourished. Sino-Japanese trade grew to $340 billion in 2014, with China emerging as Japan’s leading trade partner and Japan becoming China’s second-largest trading partner. Japanese investment in China followed a similar trajectory, growing to more that $100 billion in 2014, making Japan the leading source of foreign investment for China.

However, a newer phenomenon is the growing complementarity between the realm of economics and geopolitics. More specifically, contrary to the neo-liberal narrative that growing economic integration will eventually give way to a lessening of geopolitical tensions, we have instead witnessed the spill over of geopolitical rivalries into the realm of economic interactions. To be sure, this development is not unique to Asia but rather forms part of a broader global trend in which globalization is increasingly challenged by neo-mercantilism, and in which economic interdependence fails to act as a brake on conflict. The strain on Europe’s economic relationship with Russia following Moscow’s annexation of Crimea in 2014 is evidence of this.

In Asia the rise of geo-economics – the correlation of geopolitical considerations with economic interests – can be traced to China’s abandonment of Deng Xiao-ping’s mantra of “biding time” and maintaining a low profile in international relations. Coming on the heels of the trans-Atlantic financial crisis of 2008, China has demonstrated greater assertiveness in the geopolitical domain. In doing so, it has not shied away from using its economy as a tool of geopolitics. Early evidence of this was China’s “weaponization” of trade through a ban on the export of rare earths in 2010 and restrictions on the import of bananas from the Philippines in 2012, both of which followed tensions over maritime territorial disputes in the East and South China Seas, respectively.

This trend has only grown in prominence under the more assertive leadership of President Xi Jinping in China. In part, this can be attributed to China’s economy moving up the value-chain towards more high-end manufacturing while its outbound investments have moved away from resource extraction towards exporting capital goods and construction services (areas that increasingly overlap with Japan).This comes amid the re-balancing of China’s economy toward a “new normal” of slower growth, which has resulted in a proclivity by Chinese companies to seek overseas growth opportunities and export excess industrial capacity through overseas infrastructure projects. This has been facilitated by initiatives such as One Belt, One Road (also known as the 21st Century New Maritime Silk Road and Silk Road Economic Belt) and the drive to improve the efficiency of China’s state-owned enterprises in order to create national champions that can more effectively compete on the world stage. The numbers speak for themselves: China’s outbound investment has surged from $2 billion in 2004 to over $80 billion in 2014 and almost $120 billion in 2015. In many ways, the Chinese outbound investment story echoes what happened in Japan in the 1980s when the re-valuation of the yen against the U.S. dollar following the 1985 Plaza Accord prompted many Japanese companies to go global to compensate for Japan’s slowing growth and rising production costs at home.

With respect to Japan, Japanese companies have increasingly pursued a “China Plus” strategy of diversifying their investments in Asia beyond their traditional focus on China. This has been fuelled by both commercial considerations (such as rising labor costs and poor enforcement of intellectual property rights in China) but also by political factors such as the potential for Japanese brands to come under scrutiny and even attack during periods of deterioration in the Sino-Japanese relationship. It has been complemented by a more proactive and omni-directional foreign policy under Japanese Prime Minister Shinzo Abe, which has entailed stepped up engagement with the region’s other fast-growing economies, including Vietnam, the Philippines, Indonesia, and Myanmar. In doing so, Southeast Asia has now emerged as Japan’s leading investment destination in Asia.

Railway Rivalries

In this context, China and Japan have increasingly emerged as regional economic competitors, as evidenced by their nascent rivalry in securing lucrative infrastructure contracts. The most visible sign of this has been in the railway industry: In October 2015 a Japanese consortium lost a $5 billion contract to China Railway Group to build Indonesia’s first high-speed railway connecting Jakarta and Bandung. The same year, Japan leveraged its burgeoning relationship with India to secure a $15 billion deal to construct a high-speed line between Mumbai and Ahmedabad. Japan is also due to begin construction of a high-speed rail link in Thailand while Chinese companies have begun work on a railway project in Laos. Both countries along with South Korea are also engaged in a bidding war over a high-speed rail link between Singapore and the Malaysian capital, Kuala Lumpur. To counter China’s cost advantage Japan has pledged better technology and safety standards and operational support over the full lifecycle of its projects. It has also offered more benefits to local economies through hiring and training local workers, as opposed to the common Chinese practice of importing labor for Chinese-funded infrastructure projects.

This competition to sell high-speed rail infrastructure has emerged as microcosm of a broader Sino-Japanese rivalry for industrial supremacy in Asia, with power generation, nuclear power, telecoms, and port and road infrastructure also emerging as areas of potential competition. In this nascent rivalry, the region’s multilateral lending bodies could emerge as new platforms of competition in the bilateral relationship. To be sure, it would be an exaggeration to characterize the Asian Development Bank (ADB) and the Asian Infrastructure Investment Bank (AIIB) as purely Japan or China-led organizations, with the ADB maintaining 67 member states and the AIIB having 57 founding members. Moreover, the relationship between these bodies is unlikely to be purely competitive, as evidenced by efforts by the AIIB to adopt the best practices of the more well established ADB with respect to labor, environmental and anti-corruption safeguards while both organizations identify opportunities for co-financing projects. However, China and Japan’s overwhelming influence in the AIIB and ADB (with both countries holding the largest voting share in their respective organization) ensures a degree of rivalry in their activities.

Furthermore, this rivalry is unlikely to be confined to East Asia. For instance, both countries are seeking to strengthen economic connectivity in the Eurasian region through such initiatives as the Central Asia Plus Japan dialogue and China’s Silk Road Fund and Shanghai Cooperation Organization (SCO). China has also concluded an agreement to provide financial support to Iran to build the country’s high-speed rail network, which came on the heels of Xi’s visit to the country in January following the lifting of international sanctions on the country the same month. Japanese Prime Minister Shinzo Abe will follow this up with a visit to Iran in August, the first official visit by a Japanese leader since 1978, which aims to strengthen economic ties with the country.

Winners and Losers

The recipients of these investments will be the main beneficiaries of this competition as they seek to leverage the Sino-Japanese rivalry to secure the best investment terms. For instance, the Indonesian government was able secure a loan from the China Development Bank for the high-speed rail project with minimal financial burden. Similarly, a plethora of deals were concluded during Xi Jinping’s visit to India in September 2014, including a five-year economic and trade development plan that entails the development of industrial parks and the upgrading of India’s rail network. The fact that Xi’s visit to India came on the heels of Indian Prime Minister Narendra Modi’s visit to Japan the same month demonstrates the Modi government’s ability to leverage the latent rivalry in the Sino-Japanese relationship to maximize investment commitments from both countries.

However, this competition may also prompt companies from both countries to cut corners and make irresponsible investments that face greater financial, operational or political risk. The Chinese high-speed rail project in Indonesia is already running into difficulties, which has raised concerns that it could follow in the footsteps of an infamous contract for the Northrail project in the Philippines that China won in 2004 but ultimately shelved in 2012. This alludes to a persistent gap in the rhetoric and reality of China’s overseas investment commitments. Even once these projects have got off the ground some have them have been mired in controversies related to social, environmental, commercial and/or security risks. For instance, Australia’s Foreign Investment Review Board has recently increased scrutiny of sales of critical infrastructure, such as ports and utilities, which has been partially fuelled by concerns over Chinese investment. China’s deteriorating relations with Myanmar and Sri Lanka in recent years have also been ostensibly linked to concerns over the terms and nature of Chinese investment in these states (although controversial Chinese-funded infrastructure projects that have been suspended such as the Myitsone dam and hydroelectric power project and Letpaddaung copper mine in Myanmar and Port City project in Sri Lanka have subsequently been resumed). These investments could also create problems back home through a surge in toxic debt and defaults, fuelled by the risk of expropriation and concerns over the absorptive capacity of such massive financial commitments in recipient countries. Questions are also being raised about the actual need for the technologies being flaunted by China and Japan, including high-speed rail, which requires a particular distance and population demographic to be lucrative and effective. In this context, it may make more sense for both countries to develop intra-city railway systems, such as the Japan-funded Delhi Metro in India, rather than long-distance high-speed inter-city rail.

Meanwhile, despite the hype of the Sino-Japanese railway rivalry, this nascent competition may be cut short by the economic challenges that confront both countries. For China, Xi’s anti-corruption campaign has created a more risk-averse outbound investment climate. The slowdown in China’s economy has also led to a growing discussion of a replay of the late 1990s, when the Chinese economy underwent a massive restructuring amid rising unemployment and debt levels and the privatization and consolidation of state-owned enterprises (SOEs). The concern in China is not so much that of a hard-landing (given the strong buffer provided by China’s massive foreign exchange reserves) but rather slow progress in structural reforms, such as “supply-side reforms” aimed at cutting excess industrial capacity and overhauling SOEs, which includes the possibility of allowing them to fail if necessary. Similarly, in Japan, despite the hype of Abe’s “three arrows” reform agenda (comprising fiscal stimulus, monetary easing and structural reforms), the Japanese economy remains in the midst of deflationary pressures.

Ultimately however, these developments are likely to merely delay rather than deter the competition for industrial primacy in Asia. The recent bid by Chinese SOE Chemchina for Swiss agricultural company Syngenta, if approved, will be the single largest Chinese foreign acquisition to date. This demonstrates that despite concerns over a slowdown in outbound investment and more risk-averse investment climate, China will remain an important economic player on the world stage. The structural reforms that China underwent in the late 1990s were facilitated by the country’s admission to the World Trade Organization in 2001. Similar external pressures such as Japan’s admission to the U.S.-led Trans-Pacific Partnership free trade agreement may force both countries out of their complacency and prompt them to enact necessary but painful reforms.

Should they do so, new avenues of geo-economic competition are likely to present themselves. There are already signs of this with both countries building up their defense export industry. Having lifted a 70-year ban on military exports in 2014, Japan is vying for a contract to export its Soryu-class submarines to Australia while securing a deal with India for its ShinMaywa US-2 amphibious aircraft. China has a clear lead in this race, having emerged as the world’s third largest exporter of arms, with shipments growing by 143 percent in the last five years, according to the Stockholm International Peace Research Institute. Moreover, as the rate of increase in China’s defense budget slows to single digit levels, a growing space has emerged for private sector companies in competitive tenders for military procurement, with the PLA’s General Armaments Department announcing 505 open tenders so far.

Military Dimensions

Finally, there are also possibilities for this largely economic rivalry to spill over into the military arena as China and Japan build up their power projection capabilities to protect their overseas investments. The reinterpretation of Japan’s pacifist constitution to permit “collective self-defense” has already given its Self-Defense Forces the mandate to expand overseas operations, as evidenced by participation in anti-piracy patrols in the Indian Ocean and regular air patrols, port calls and joint naval exercises in the South China Sea. China’s 2015 defense white paper also makes specific reference to the need to protect Chinese “institutions, personnel and assets abroad.” In operationalizing this objective China passed a new counterterrorism law in December 2015, which lays the groundwork for the PLA to be sent abroad on counterterrorism operations with the consent of the country where it is intervening, in contrast to its long-standing position of non-interference in the internal affairs of other states.

Putting this law into practice may come sooner than expected given China’s investment in precarious states ranging from Afghanistan to Sudan. The country’s humanitarian response capabilities have already been put to the test with the evacuation of its civilians from civil wars in the Middle East. A Chinese missile frigate was deployed to the Mediterranean Sea in early 2011 to support the evacuation of more than 38,000 Chinese nationals from Libya. The PLA Navy also evacuated more than 600 of its nationals from Yemen in 2015. The instabilities in Iraq and Syria could provide a further test for China given its sizable interests in the country as a leading buyer of Iraqi oil and the presence of some ten thousand Chinese nationals in that country. The agreement on the establishment of the China-Pakistan Economic Corridor in April 2015 is also likely to prove a challenging investment for China, prompting Beijing recently to propose a joint counterterrorism mechanism with Pakistan, Afghanistan and Tajikistan.

Great Power Rivalries

Recent years have seen growing concern over the potential for great power rivalries in Asia fuelled by the military modernization efforts of regional powers and their proclivity to project power, particularly into the maritime domain. China’s actions have been the most obvious illustration of this through its recent land reclamation activities in the South China Sea, declaration of an air defense identification zone in the East China Sea in 2013, and the deployment of the PLA Navy to far-flung regions of the world. However, notwithstanding the possibility of accidental skirmishes, the cold wars of East Asia are unlikely to echo the hot wars of West Asia (Middle East) any time soon.

Rather, the most likely stage for competition is in the geo-economic domain as regional powers seek to leverage their growing economic clout to expand their regional and global influence. While regional economic integration will continue to flourish, the reversal of regional supply-chains and production networks, particularly in China, which increasingly emerges as a source rather than a destination of foreign investment, sets the stage for a growing geo-economic rivalry in Asia. In this context, infrastructure financing, supported by trade and investment deals, institutions such as the AIIB and ADB and initiatives such as China’s OBOR and Japan’s Central Asia Plus Japan Dialogue, are likely to emerge as arenas of growing competition.

Nor are China and Japan the only players in this nascent competition. Notably, if Prime Minister Narendra Modi’s “Make in India” initiative is able to gain traction and sustain momentum, India’s manufacturing exports could some day rival those of Japan and China. While India is not in the same league as China in its efforts to create globally competitive “national champions,” India has nonetheless demonstrated a nascent drive to create more efficient public-sector undertakings (state-owned enterprises) through an emphasis on “strategic sales” or disinvestment (privatization) drives and reducing state subsidies. Modi’s pragmatic and omni-directional foreign policy, which has seen him visit 32 countries in less than two years, is also aimed at engaging all major poles of influence in the international system in order to highlight the attractiveness of the Indian economy and seek business and investment opportunities.

For instance, one potential area of future competition between China and India in the geo-economic domain is overseas land acquisitions aimed at feeding the growing appetites of both countries’ massive populations and middle classes. This has been evidenced by the emergence of Chinese company Shanghai Pengxin as one of the world’s leading private landowners, with acquisitions in Argentina, Bolivia, Cambodia and New Zealand, and another Chinese company, Moon Lake Investments acquiring Australia’s largest dairy operation, Tasmanian Land Company. China’s growing seafood consumption – which accounts for almost 40 percent of the world’s fish consumption – is another contributing factor to China’s maritime territorial claims in the South China Sea. As such, food security could prove to be the next resource rivalry on par with the commodity super-cycle of the last decade.

Ultimately, these developments illustrate that the economic and geopolitical domains are not mutually exclusive but rather mutually reinforcing. The geopolitical component of economic interactions are likely to gain salience amid growing investment in strategically important and sensitive sectors such as transport, telecoms and defense, which will often be dictated by the state of bilateral relations between countries. In some cases, cordial bilateral relations may facilitate stepped up economic interactions, as is the case in Japan’s burgeoning relationship with India, which has encouraged investment in several high-profile infrastructure projects, including the Delhi-Mumbai and Chennai-Bangalore Industrial Corridors. At the same time, greater economic interaction may quell latent political tensions, as seen by the establishment of a working group between Japan and Russia on expanding cooperation in infrastructure development, which may offer a means to normalize relations between Tokyo and Moscow and seek a resolution to their long-standing territorial dispute over the Northern Territories/Southern Kurils. Either way, geo-economics – characterized by “the grammar of commerce but the logic of war” – is likely to increasingly challenge the traditional separation of the economic and geopolitical arenas in East Asia.

 Chietigj Bajpaee is a doctoral candidate in the Department of War Studies at King’s College London. He has worked with several public policy think-tanks and political risk consultancies.