平和
和平
평화
JAPAN
25 March 2014
Beijing September 2012

Japan's Chinese investment risk

China's dramatic rise has been driven by international investment and trade, especially with Japan. But today, political tensions between the two countries are threatening this relationship.

China's dramatic rise has been driven by international investment and trade, especially with Japan. But today, political tensions between the two countries are threatening this relationship.

The initial instigation for Japanese investment in China was Vice Premier Deng Xiaoping's 1978 visit to Japan, the first visit of a Chinese state leader to Japan. Deng visited a Panasonic TV factory in Osaka and asked company founder Konosuke Matsushita to help him modernize China’s electronics sector.

Moved by the personal appeal for help, Matsushita, then 83, vowed to do everything he could. He visited China and found factories using technology from the 1940s. Throughout the 1980s Matsushita transferred technology, trained Chinese workers and otherwise helped China modernize its industry through 150 separate projects.

China learned how Matsushita made everything from electric irons to transformers and semiconductors. In return, Matsushita earned the Chinese government’s goodwill and gained unparalleled expertise in manufacturing and selling in the Chinese market.

Panasonic's investment in China was part of the wave of Japanese investment in emerging Asia that was a crucial driver of the region's development. The earlier waves of Japanese overseas investment were substantially in the US and Europe, and very often in response to protectionist reactions to Japan's export prowess, especially for automobiles.

The trigger for the take-off in Japanese investment in Asia was the appreciation of the Japanese yen after the Plaza Accord in September 1985. The yen rose by 60% against the US dollar between September 1985 and September 1986. As Japanese firms lost price competitiveness, they responded by shifting labor-intensive assembly operations to other Asian countries.

Korea and Taiwan were the initial destinations for Japanese investment. But as these economies developed rapidly, they also experienced rising wage costs and appreciating currencies too. Thus, Japanese firms then switched their investment focus to the Southeast Asian countries of ASEAN.

The 1997-98 Asian financial crisis and its associated instability undermined the attractiveness of Southeast Asia. And then China's membership of the World Trade Organisation in 2001, and the associated confidence in China's reform path, boosted its attractiveness as an investment destination. Another factor was the 1988 signing of a bilateral investment treaty with China.

While Japanese firms did not disnvest from ASEAN countries, they did shift their focus to China. Thus followed a wave of Japanese investment, which propelled Japan to the ranks of a global investment giant.

As a result, Japan is now the world's second most important investor nation, after the US, with a stock of over $1 trillion in accumulated overseas investment. About 47% of this investment stock is in manufacturing industries and 53% in non-manufacturing activities like finance/insurance, wholesale/retail etc. And about 30% of this investment goes to Asia (of which 10% in China), about the same as its investment in North America and more than Europe. And in 2011, its outflows of foreign investment were still the world's second highest, and well ahead of China.

Much noise is made today about China overtaking Japan to become the world's second biggest economy, and about Japan's long period of domestic economic malaise. But when it comes to international business, Japan is still the world's second biggest investing nation, and its enterprises succeed famously on the world stage. Chinese large enterprises, most of which are still state-owned, are not yet in same league.

Indeed, leading Japanese manufacturing companies do more business overseas than at home. Overseas sales for the top 50 Japanese companies in the manufacturing industry (transportation equipment, electrical equipment, machinery, precision equipment) rose from 56% of total sales in 2011 to 59% in 2012, with one-third of these sales being to Asia. The 2012 overseas sales ratio was 65% for transportation equipment, and 51% for electrical equipment.

Japan's investment in China and elsewhere in Asia has enabled the region to participate in the explosion of "global value chains" this past decade. The creation of these value chains, which are really more regional than global, has been led by Japanese multinational enterprises. They are most developed in the electronics sector for which parts and components are small and light, and can be easily shipped from country to country for processing and assembly.

Asian countries perform different "tasks" in the value chain, consistent with their comparative advantage. For example, Japan and Korea usually specialize in product design and high-tech component manufacture, while China tends to specialize in lower value added assembly activities. Much of East Asia's manufacturing activities ultimately target Western markets, although as emerging Asia's middle class population grows in size, this new market will increasingly become a target.

Without the fragmentation of production processes into these value chains, China's trade and investment potential would be much lower. And participating in value chains has many benefits in terms of technology and knowledge transfer, which ultimately enables countries like to China to climb the value chain and perform high value-added tasks.

This beautiful economic partnership between China and Japan was able to survive the political disturbances during Koizumi's prime ministership of Japan from 2001 to 2006, when he upset neighbours by visiting the Yaukuni Shrine.

But more recently, political relations between China and Japan have been in a tailspin, with an escalating dispute since 2010, and especially since 2012, over the Senkaku Islands (Diaoyu Islands in Chinese). Last year, violent protests took place against Japanese businesses and products. Panasonic saw serious damage inflicted on some of its facilities by anti-Japanese protestors, as well as sabotage from workers, and had to close three factories (in Qingdao, Suzhou and Zhuhai) for some time. Negative consumer reaction also saw losses in China sales.

This rising Chinese country risk is taking place at the same time as China is also experiencing wage rises, and a loss of competitiveness and attendant labor disputes. Panasonic even had one case where Chinese workers at a plant in Beijing confined management to their offices for several hours while demanding explanations of plans to reduce the workforce.

As a result, in 2013 Japanese firms have been substantially switching investment from China to Southeast Asian countries, a trend that appears to have begun in 2010. This also makes sense given that some ASEAN countries are party to the Trans Pacific Partnership trade talks, whereas China is not. And Japanese firms will still be able to export to China from their ASEAN bases, as ASEAN has a free trade agreement with China.

Switching away from China has also been supported by a major diplomatic initiative by Japanese Prime Minister Abe who is courting the ASEAN countries, all of which he has already visited. And this very week, a Japan/ASEAN summit is being held in Tokyo.

Irrespective of the rights and wrongs of the China/Japan dispute, it is clear that it has very great economic costs to both sides. China is still very low on the global technological ladder and can continue to benefit from investment from Japanese firms like Panasonic. While Japan, with its economic maturity and aging population can also benefit from cooperation with high growth markets like China.

We can only hope that one day good sense will prevail and enable China and Japan to benefit from a mutually beneficial trade and investment relationship. Most regrettably, there is no sign yet of such good sense. Hold your breath!

Author

John West
Executive Director
Asian Century Institute
www.asiancenturyinstitute.com
Tags: japan, investment, FDI, Chinese country risk, global value chains, Panasonic

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