Tokyo Report | Economy | East Asia

The Challenges and Opportunities of Japan-Russia Economic Relations

On paper, Japan and Russia have complementary economies. In reality, trade and investment ties have been hard to forge.

The Challenges and Opportunities of Japan-Russia Economic Relations
Credit: Russian Presidential Press and Information Office

After their respective returns to prominent power in early 2010s, both Prime Minister Abe Shinzo of Japan and President Vladimir Putin of Russia realized that the lack of a diplomatic breakthrough in Russo-Japanese relations put Russia and Japan at a disadvantage in great power maneuvering. Cooperation between the two states would satisfy Putin’s advocacy for multilateralism and Abe’s hope for a more independent and robust Asian policy. In addition, after the Fukushima nuclear disaster of 2011, Russia appeared as an ideal energy supplier to satisfy Japan’s growing fossil fuel demands. As a result, Abe and Putin initiated efforts to improve Japan-Russia economic relations.

Following the Abe-Putin summit in 2013, Japan increased its energy investments in the Russian Far East. Gazprom and Japanese companies signed a memorandum of understanding that approved Vladivostok LNG, the flagship project of the Putin-Abe era. However, the process has stagnated since 2013 because Gazprom devotes more attention and resource to projects with China. Likewise bilateral trade has had a rocky path. Japan-Russia trade enjoyed rapid growth following the 1998 financial crisis until the Ukraine crisis. Japanese exports to Russia peaked in 2012 and took a sharp hit in the next two years because of sanctions against Russia following the annexation of Crimea. Currently, Japan’s exports to Russia are only around 50 percent of their 2012 level. Japanese imports from Russia peaked in 2013 and 2014 and steadily declined to the current level, around half of the peak.

The failure to strengthen economic ties during the Abe-Putin era represents a general trend in the past 50 years. On paper, Russia and Japan are ideal trade partners: Russia needs Japanese investments and technologies while Japan needs Russian natural resources. Despite these mutual needs, Japan and Russia have consistently failed to boost bilateral trade. The bad business environment in Russia and its economic decline after the annexation of Crimea are the two most pressing issues that are keeping the bilateral trade relations down.

The Japanese government and businesses alike identify the Russian business environment as the biggest obstacle to investment. In a major, ongoing study of Japanese investors’ attitudes toward Russia conducted by the Japan External Trade Organization (JETRO), 74.2 percent of the companies identified the“unstable political and social climate” as the most pressing risk for their investment. In addition, 67.5 percent of respondents pointed to the complexity of administrative procedures, and 59.1 percent of respondents cited the complexity of the tax system. Japanese industry groups complain of numerous obstacles to investment in Russia, such as organized crime, corruption, lack of a coherent legal framework and transparent tax rules, and power struggles between the Maritime Provinces and Moscow. As a result, Japanese investments in Russia remain minuscule. In 2017, Japanese investment in Russia represented just 0.07 percent of total Japanese oversea investment. Unless Russia improves its business environment significantly, Japan is unlikely to improve its business ties with Russia.

Russia’s declining economic trend after the annexation of Crimea brought more worries to Japanese investors. First, the volatility of the ruble became a significant concern. In the JETRO survey, 78.5 percent of respondents identified “exchange rate volatility” as the most urgent risk for their investment in Russia. The ruble’s shifting value is closely connected to the decline in oil prices, which in turn makes investing in energy projects less attractive. The fluctuation of the ruble also made stable and future-oriented trade and investment impossible. In addition, the Russian market became less attractive for investors in the manufacturing sector because of the shrinking economy and the decline in disposable income.

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Second, Japanese firms worry about post-Crimea sanctions. The Japanese government introduced its own sanctions as part of the G-7’s collective action against Russia. However, it was the European and U.S. sanctions that worried Japanese investors the most. They worry about the possibility of oil and gas technologies being included in the U.S. sanctions list and fear that the U.S. Treasury Department might sanction Japanese companies over specific projects in Russia. Japanese companies remember the harsh punishment of Toshiba in 1987 over sales to the Soviet Union; they do not want to repeat it.

Despite these challenges, there are new opportunities for increasing economic ties in the energy and agricultural sectors. Japan has increased its reliance on fossil fuel energy sources following the 2011 Fukushima nuclear meltdown, bringing new urgency to energy cooperation. The disaster brought a new wave of anti-nuclear protests in Japan, and it also unveiled the deep-rooted corruption of the Japanese “nuclear village,” the network of business, bureaucrats, and regulators that runs the nuclear industry. The post-disaster parliamentary inquiry found that Fukushima was a profoundly manmade catastrophe. Collusion between Tepco, the company that ran the Fukushima nuclear plant, and government agencies made regulations meaningless. After the disaster, Japan planned to decrease its reliance on nuclear power. Currently, only nine out of the 39 nuclear reactors are operating, and the government plans to phase out nuclear power completely by 2040. The decreased reliance on nuclear energy brought an increased need for alternative sources of electricity generation. Due to its geographic closeness to Japan and rich oil and gas reserves, Russia is a natural solution to Japan’s rising energy problem.

Agriculture has also emerged as a new area of Japan-Russia cooperation. Hokkaido, the food basket of Japan, takes the lead in this process. The geographical closeness and similar climate make Hokkaido and the Russian Far East natural partners in agricultural development. Hokkaido provides technologies for cold climates, such as greenhouse agriculture, small smokeless incinerators, and vegetables that are well-adapted to a cold environment. A joint Hokkaido-Sakha project started in 2015 built a 30,000-square-meter greenhouse farm with Japanese technologies. In exchange, Russia exports cheap crops to Hokkaido for livestock feed.

After Hokkaido’s initial success, the Japanese government developed a comprehensive agricultural investment project in the Russian Far East. First, this project aims to improve agricultural productivity in Russia by adopting Japanese agricultural machinery, fertilizers, agrochemicals, and food processing technologies. The increasing yield will expand the export potential of soy, corn, wheat, rapeseed, forage grasses, livestock products, wild berries, and processed products to Japan. Second, this project invests in improving existing greenhouses and building new greenhouses for year-round cultivation of fresh and safe vegetables by using Japanese technologies. It also promotes the growth and production of outdoor vegetables using technologies and know-hows from Japanese private companies. Third, the project aims to increase the production and value-added processing of seafood products by using Japanese processing, preservation, and packaging technologies.

In both Moscow and Tokyo, Japan-Russia economic relations often take a back seat compared to other bilateral relations. This low priority contributes to the weak bilateral economic relationship. In the eyes of Japanese policymakers, trade relations with Russia are less important than Japan’s relations with China, the United States, and even Southeast Asia. For Putin, the improvement of Japan-Russia trade relations is only a tool to lure Japan away from the U.S.-Japan security alliance. Furthermore, as the Vladivostok LNG project demonstrates, Japan’s economic significance further declines as a rising China can provide more and more market opportunities and capital to Russia. Thus, the current trade status will not change unless Russia and Japan change their foreign policy priorities. However, that said, new opportunities in the energy and agriculture sectors may cultivate mutual trust that leads to a future economic breakthrough.

Zhuoran Li is a master’s candidate in international relations at the School of Advanced International Studies (SAIS), Johns Hopkins University.