A lot to lose

Despite icy diplomatic relations of recent years, Sino-Japa-nese economic interdependence has steadily deepened as the flow of Japanese capital, goods and people into China topples records year after year.

Japan is China's second largest trade partner after the US, although until 2003 Japan had been China's top trading partner for 11 years. Conversely, China is Japan's largest trade partner, a title, until last year, had been held by the US since the end of World War II. With bilateral trade between them exceeding US$210bn last year, Japan's trade with China accounts for one-fifth of its foreign trade.

China, not a commercial foe
"One remarkable change that has taken place in the last few years is the changing Japanese perception of China," says Masahiko Ishizuka, Nihon Keizai Shimbun's Hong Kong bureau chief before becoming a Foreign Press Center adviser in Tokyo. "China was seen as a threat because [it] has low labor cost and Japan couldn't compete with that, but now China is seen as an opportunity." China-Japan trade has largely been balanced, although China continues to register a trade surplus, thanks to growing Japanese appetite for cheap Chinese commodities like agricultural products, low-level machinery, shoes, garments and textiles. And by feeding China's demand for machinery and equipment, chemicals, steel, electronic components, Japan has steered clear of a recession. "Japanese exports [to China] have expanded beyond our expectations," says Toshi Kinoshita, an East Asian economist at Waseda University in Tokyo. "Between 24% to 30% of Japan's growth may be explained by the unexpected favorable export to China."

Japan has a lot riding on China: Last year, Japanese investors poured US$5.5bn into China. Through joint venture investments, Japan has set foot in China's flagship industries: Nippon Steel's venture with Baosteel, ITOCHU Corp's with China Railway Modern Logistics Technology Co, the ubiquitous joint ventures with Japan's auto giants, among others.

Besides capital, jobs are another Japanese import, with Japanese-invested companies in China, including joint ventures, employing a total of 9.2 million workers, according to new data from China's commerce ministry (32,000 Japanese companies employed one million Chinese workers in 2004, according to the Japanese embassy in China). These figures do not account for the workers hired to keep Chinese-owned factories humming 24/7 to fill Japanese orders (there are, for example, 4,000 Chinese manufacturers that supply to Sony Corp, according to the Shenzhen Economic Daily).

Uncertain times
Recent hits taken by Japanese businesses signal more tenuous times while underlining the deepening links between the two economies.

On April 18, more than a week after thousands in Beijing, Shenzhen and Guangzhou took to the streets, Japan's Nikkei stock index plummeted 3.8%, its biggest one-day drop in more than 11 months, as investors dumped issues with large China exposure like Mitsui OSK Lines Ltd, electrical machinery maker Fanuc Ltd, and Sony Corp.

The pain is all too real for travel-related industries on both sides as widely reported cancellations in the thousands by Japanese visitors see no let-up. Shanghai could be the big loser, as it was the destination for a third of the record 3.3 million Japanese who visited China last year, accounting for about 20% of China's total foreign visitors (after Taiwan and Hong Kong, Japan has the most visitors to the Mainland).

Politics could also derail Japan's hopes to sell Shinkansen technology to China's proposed US$12bn Beijing-Shanghai high-speed railway – if Beijing follows the example of South Korea, which rebuffed a bullet train contract over Japan's failure to make restitution for its wartime "comfort women" program. "In my opinion, the timing is not good, " says Yasuo Sone, head of economic research at Nomura International (Hong Kong) of the recent tensions. "It might affect the decision by the Chinese government," he says.

But boycotts of all things Japanese can risk revealing harsh realities, as Waseda U's Kinoshita points out. "Even though the young generation wishes to boycott Japanese goods, many of the parts in the Chinese goods they buy are produced by Japanese companies," he says.

And then there is the more obvious risk. "The anti-Japanese sentiment could spur anti- Chinese sentiment in Japan," says Hatakeyama Tadahisa, chief representative of the Japan-China Association on Economy and Trade in Beijing, adding that the aftermath will be measured in terms of dented investments and trade, as Japan has for years been among China's top three in trade and foreign direct investment.

High stakes
According to Xiao Min Jie, a Daiwa Research Institute economist, China's manufacturing base – both foreign and domestic – would be severely hampered without Japan. Indeed, 54.2% of Japan's export to China is producer goods, 29.8% is capital goods, and 11.5% is consumer goods, according to Sone.

Japanese capital equipment is also indispensable to China's infrastructure drive. Without its construction machinery and trucks, for instance, China would not have the means to prepare for the 2008 Olympics, says Kinoshita less convincingly.

But equally critical is Japan's know-how, which has been credited for developing China's electronics supplier base. For more than 20 years, Japan has steadily transferred technologies for products ranging from fiber optic cables to supercomputers to VCRs, according to the US-based World Technology Evaluation Center. Economists say the knowledge transfers will continue as Japanese manufacturers continue to invest in production and sales in China, and with Chinese manufacturers still in the throes of a learning curve, they will look to Japanese technology transfers that come with their sophisticated machinery.

"Right now, China needs Japan more than the other way around," says a Shanghai businessman whose 1,200 employees use Japanese equipment to churn out TV remotes and other products sold to manufacturers in Japan. "It's not a 50-50 give-and-take, it's more like 60-40, and Japan has the upper hand, because they have the know-how and the technology. China only has land and human resources and comparatively little know-how."

Politics enter the fray
Chinese state coffers have been enriched by Japanese funds for as long as tax-paying Japanese companies have operated in China, and since 1979, China has received a total of US$30bn in ODA funds from Japan.

As China's economy expands, its dependence on Japanese funds is diminishing. "China is entering a new era of development, and is itself giving aid to third world countries" Sone says.

Meanwhile, in keeping up with its rival, Japan is trying to make new friends, with Japanese Prime Minister Junichiro Koizumi recently courting Asia's other powerhouse, India, following an itinerary similar to that of Wen Jiabao, who toured Southeast Asia a month ago in a bid to consolidate China's regional influence. Some see Koizumi's trip as a hedge against Japan's large investments in China. "The Indian economy is picking up," Kinoshita says. "For Japan, India will be an important country economically and politically."

However the politics play out, the commercial ties between the two economies will rise above them. "Japanese companies expect China to be a big market for their products," Nomura's Sone says. "In the long term, this strategy won't change – Japan will continue to explore the Chinese market."