China vs. Japan: A Phony Trade War

The two nations are already inextricably tied

To hear the rhetoric, a full-blown trade war could erupt any moment. In recent months, Tokyo and Beijing have been lobbing tit-for-tat import tariffs that have made for explosive headlines. Japan International Trade & Industry Minister Takeo Hiranuma says that the damage inflicted by China could be "quite substantial," even as Beijing lays the blame squarely on Tokyo. Says Xu Changwen, a director at the Chinese trade ministry's research academy: "If there's a trade war, that will affect Japan's ability to do business here."

The trade spat between the two titans has escalated rapidly since April. That was when the Japanese government, under pressure from the farm lobby, slapped tariffs on Chinese mushrooms, leeks, and the reeds used in tatami mats. In late June, Beijing imposed tariffs on Japanese cars, mobile phones, and air conditioners--and Japanese carmakers have now vowed to halt the exports of autos to China. As Japan's ruling Liberal Democratic Party gears up for crucial July 29 elections, the country's farmers and small manufacturers are agitating to slow the flow of everything from Chinese hand towels to chopsticks to bicycles.

From all appearances, then, the trade battle is causing irreparable harm to the two giants' relationship. But appearances can be deceiving. In fact, the two economies already are deeply integrated--and are growing more so every day. And nothing that has happened is likely to change that. "In spite of diplomatic problems from time to time," says Japan Finance Vice-Minister Haruhiko Kuroda, "we see a close economic relationship between the two countries." Indeed, the brouhaha over produce and straw mats shows just how reliant the Japanese have become on China to fill their sukiyaki hotpots and also furnish their homes.

The numbers bear this out. Bilateral trade hit an all-time high of $85.73 billion in 2000 and, according to the Japan External Trade Organization, is on track to surpass the $100 billion mark this year (chart). Last year, Japan's trade deficit with China totaled $24.88 billion--making China one of the few non-oil-producing nations to sell more to Japan than it buys. The trade spat is, in effect, a side show to the real story: that Japan already is China's biggest trading partner, while China ranks as Japan's No. 2 after the U.S. This is a rapidly growing relationship that will alter the dynamics not just of Asia, but the entire world.

LESS JUNK. There's no denying that the booming trade across the East China Sea is a boon to both sides. For proof of this in Japan, one need venture no further than one of the 500-odd UNIQLO outlets operated by Fast Retailing Co., the sleeper discount clothing chain that has become an overnight sensation. Almost everything sold at UNIQLO shops is sourced from some 65 plants in China. "Just because it's made in China doesn't mean it's junk anymore," says Michio Ichizawa, a 36-year-old lawyer, after recently buying a belt, T-shirts, and a cotton, long-sleeve shirt at UNIQLO for a mere $50.

For its part, China is inhaling Japanese investment. According to Beijing, Japanese foreign direct investment totalled $2.9 billion last year, up 7% from 1999. For 2001, Japanese companies have pledged $3.7 billion. The money is pouring into Japanese joint ventures and wholly owned Chinese manufacturers that are gobbling up outsourcing business from the likes of Mazda Motor Co. and Fast Retailing.

MOVING UPSTREAM. With their competitive edge eroding fast, Japanese companies increasingly see China investment as an imperative. Even such blue-chip manufacturers as Sony Corp. and Matsushita Electric Industrial Co. are rushing to expand production and sourcing in China. They're there, of course, for the low price of labor and materials, but also because Chinese workers are becoming increasingly sophisticated. "The quality of Chinese production has improved a lot in recent years," says Shigeharu Hiraiwa, a director at Mazda, which began production of the Premacy SUV in Haikou in May, and expects to make 20,000 a year by 2004. Mazda engineers rate the China-built Premacys slightly lower than those made at the company's Hiroshima plant, says Hiraiwa, "but they're quite close."

Indeed, Japanese companies are making more and more high-tech products in their Chinese factories. Pioneer's newest plant in Shanghai, for example, sends most of its top-of-the-line DVD recorders to Japan, the U.S., and Europe. Many Pioneer DVD drives leave China in the bellies of exported Acer or Compaq PCs. For its part, Matsushita makes Panasonic brand mobile phones in China for the domestic market and for export to Britain.

The move upstream will only accelerate. "Increasingly higher value-added products will be produced in China and in bigger amounts," says Japan External Trade Organization head Noboru Hatakeyama. "This is an inevitable development." Japan, for its part, will try to keep a step ahead in technology so as not to lose its competitive edge. "That," he adds, "is the name of the game."

PRIDE. The irony of the trade flap is that most cheap "Chinese" products flooding Japan are made by Japanese companies. And Corporate Japan has no choice but to continue moving to China, facing as it does cutthroat competition at home due to deregulation, especially of retailing, distribution, and agriculture. Then there is the growing consumer demand for lower prices from retailers. "Japanese companies have been rushing to set up in China because they realize what will happen if they don't--consumers will vote with their wallets," says Andy Xie, an economist at Morgan Stanley Dean Witter & Co. in Hong Kong.

No wonder most Japanese companies consider protectionism futile. "Any move to block free trade will end up hurting Japan," says Honda CEO Hiroyuki Yoshino. Yoshino needn't fret about the Chinese sanctions targeting cars, though: Honda exported a grand total of 534 vehicles to China last year, and the auto maker will double its production on the mainland this year to 50,000 cars.

Still, the trade spats will sputter on. "The most important reason for the trade friction," says Zhang Shuying, of the Chinese Academy of Social Sciences, "is the growing trade volume." True, but the tiff has as much to do with Japanese pride. After all, the world's second-largest economy is losing its edge as an exporter. "Japan will not enjoy surpluses as in the past," says Yukio Shohtoku, Matsushita Electrical Industrial's managing director of overseas business.

Indeed, no protectionist measures from Tokyo will stop Japan's wrenching transition to a value-added and service economy. Nor will they halt China's rise as an export machine, the likes of which the world has never seen. The reality is that each nation will need the other as the inevitable unfolds.

By Chester Dawson, with Ken Belson in Tokyo, Alysha Webb in Shanghai, Dexter Roberts in Beijing, and Mark L. Clifford in Kuala Lumpur

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