In Japan, "China Is Sexy"

Companies heed the call of the WTO and low costs

Satoshi Iue is an astute and cautious businessman, not prone to hasty decisions. But last September, when the chairman and CEO of Japan's Sanyo Electric Co. took his first tour of a factory run by Haier Group, China's biggest appliance maker, he was smitten. "When I saw how efficiently it ran its operations, I realized it would make an ideal partner for us," Iue recalls.

By January, the two companies had agreed to a comprehensive alliance--the first of its kind for a top Japanese electronics maker. In May, Sanyo started building a $30 million factory in the coastal city of Qingdao to make compressors for Haier's home appliances. Later this year, Sanyo will market its digital products in China through Haier's sales network. "I'm amazed at how quickly China is evolving," says Iue, who just 13 months ago wasn't planning any major new China investment. "This is now a very important market for us."

Hundreds of other Japanese manufacturers are starting to sing the same tune. Of course, Japanese companies have been active on the mainland for well over a decade. But by the mid-'90s that first investment foray had fizzled due to China's ham-handed regulation, high tariffs on imported parts and products, and rampant copyright infringement. Though the capital kept flowing into China, the initial torrent definitely subsided--as did Japan's enthusiasm.

Now the Japanese are taking another hard look--and deciding they like what they see. China's low costs are more appealing than ever as Japan Inc. battles to preserve margins, keep its products competitive, and restructure at home. Labor and industrial real estate in China are still a fraction of levels in Japan. What's more, after a decade of development, China now offers new highways, port facilities, and high-speed communications. The 700,000 science and engineering grads who join the job market each year represent a fast-growing pool of research and tech talent. And Chinese officials are starting to go after counterfeiters. Japanese companies, for example, were encouraged by a Beijing court ruling in August favoring Yamaha Motor Corp., which had sued a Chinese manufacturer for using the Yamaha brand on motorcycles.

Even more important: China's entry last year into the World Trade Organization. No one expects China to adopt WTO rules overnight, but many Japanese managers have been surprised by the pace of change. "China's membership in the WTO has made much more of an impact than anyone had expected," says Yukio Shohtoku, managing director of consumer electronics giant Matsushita Electric Industrial Co.

It's a big shift. Just a year ago, the mention of China triggered anxiety attacks in Japan. Execs fretted that China would steal their technology and markets, and in the process contribute to the kudoka--or hollowing-out--of Japanese industry. But realizing that manufacturers must move production offshore to remain cost competitive, they're embracing China as their best option. Moreover, by tying its fortunes to China's dynamism, Japan will be better positioned to compete in the global economy. "Japan will emerge stronger by linking itself to China," predicts Chi Hung Kwan, an expert in Sino-Japanese economic relations at Tokyo's Research Institute of Economy, Trade, and Industry.

The result: China is hot once more. Nikkei Business, the leading economic journal, recently featured an upbeat piece titled "China's Power is Changing Japan." Aera, a popular weekly magazine, ran a special in September declaring "China is sexy." Says Masaki Yabuuchi, director of China-North Asian affairs for the Japan External Trade Organization: "Last summer everyone talked about the China threat. Now the buzz is about China as the land of opportunity."

The shift is immediately visible in Suzhou, near Shanghai. The city now has its own "Little Tokyo," with a dozen Japanese restaurants and 50 karaoke bars. And since April, Japan's two leading international carriers have doubled their service to Shanghai and Beijing for a total of 56 flights weekly.

The airlines, it seems, are busy ferrying dealmakers. Last year, Japanese investment in China jumped 57%, to $4.6 billion, the highest level ever. This year promises to be even better: Through June, Japanese companies had concluded 1,238 contracts, valued at $3.15 billion. In December, Canon Inc. will open an $80 million complex in Suzhou expected to turn out 20,000 copiers a month. Matsushita Electric Industrial this year invested $26 million in two new subsidiaries to develop semiconductors and home appliances. And in May, Toshiba Corp. said it will make 750,000 laptops annually in Hangzhou. Initially, the computers will be exported, but when China's PC market is deregulated in 2004 Toshiba plans to start direct local sales. "We need to sell as well as produce in China to make this a viable business," says Sumio Kuniyoshi, senior manager of Toshiba's China Dept.

To be sure, the road to China is still littered with obstacles. It took months of protracted negotiations before Nissan Motor Co. (NSANY ) finally inked an agreement in mid-September to invest in China's No. 3 auto maker, state-owned Dongfeng Motor Group. Chinese officials still played a prominent role, rejecting Nissan's plan to purchase a majority interest. Moreover, Nissan has to tread slowly in remaking the indebted Dongfeng--the government won't stand for mass firings.

Another complaint is that Chinese authorities, particularly in the hinterlands, still aren't doing enough to combat counterfeiters. "We try to keep our most important tech in a black box, but there's no guarantee it's secure," says Hirokazu Nakanishi, the general manager of China operations at TDK Corp., an electronics component maker that has moved 30% of its production to the mainland.

Not everyone in Japan is happy about the shift. High-tech production centers, such as Yonezawa in northern Japan and Kita-Kyushu's high-tech corridor in the south, are suffering as the big electronics companies relocate factories overseas. For example, NEC Corp. (NIPNY ) plans to shift 70% of its cell phone production to China by next March. Sanyo Electric will make all of its air conditioners in China by 2004.

Yet Japan's tech chieftains point out that mass production no longer makes sense in their country. In rapidly graying Japan, employers have trouble finding young laborers willing to take factory jobs, let alone work night shifts. So, following the example of the U.S., Japanese companies are pulling out of sunset industries and shifting low-end manufacturing offshore. "Japan will become a base for research and high value-added production," predicts Canon President Fujio Mitarai.

As the economies of the two countries grow increasingly integrated, there may be no turning back. Already, Japan ranks as China's No. 1 export market, and later this year China will overtake the U.S. to become Japan's largest source of imports. Many economists believe it's only a matter of time before China becomes Japan's biggest trading partner. Xie Kang, a professor at the Shanghai Academy of Social Sciences, predicts that China and Japan "will be leaders together in Asia." The rest of the world would do well to take note.

By Irene M. Kunii in Osaka, with Alysha Webb and Dexter Roberts in Shanghai

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