China & Japan Need Each Other?

One might say it was a political milestone: In the context of the APEC summit in Beijing Chinas president Xi Jingping met Japan’s prime minister Shinzo Abe. The last formal meeting of representatives of the two countries on the highest level dates back to 2012. The handshake of both leaders is a possible signal that both sides are willing to negotiate in regards of the dispute over the Senkaku Islands.

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Japan’s prime minister Shinzo Abe (left) and China’s president Xi Jinping. Photo: Kim Kyung-Hoon/ap/dpa

In the beginning of November the Japanese Secretary of State officially acknowledged in a meeting with his Chinese counterpart that there is a dispute over the islands. A development that can be regarded as quite a break as Tokio considers the Senaku Islands as an inherent part of Japanese territory and consequently non-negotiable. Beijing, however, claims ownership of the islands as well.

The dispute over the mostly deserted island group closely located to Taiwan not only bears the risk of a military conflict that likely would destabilize the whole region but also causes considerable damage to both economies.

While the latest approach might be a surprise it might be less so if one realizes that both countries need each other more than they want to admit.

Despite the political tensions Japan has been China’s second most important trading partner only behind Taiwan. Trade between China and Japan accounted for approximately 340 billion Dollar on average over the last couple of years. 23,000 Japanese companies have invested several hundred billion Dollar in China and created jobs for 11 million Chinese. The rising tensions, however, have caused considerable harm to both economies. The fear of a military conflict led to a melt-down in Japanese investments in China. Let alone in the first half of 2014 Japanese investments in China have dropped by 50% .

While GDP growth was positive both governments were reluctant to approach each other. Now that has changed. Even the Chinese economy slowed down. In the 3rd quarter China’s GDP growth has seen a five-year low of 7.3 percent. The Japanese economy is struggling for quite some time now. In the third quarter it fell by an annualized 1.6 percent. One might argue that if Peking and Tokyo could settle the differences they both would benefit economically.

China suffers tremendously from environmental degradation. Furthermore, production automation is an area in which improvement is needed to take the crucial steps towards becoming a highly developed country. Japan provides competitive solutions for environmental technology as well as automation and robotics. One example here are the Japanese car manufacturers (e.g., Nissan’s Leaf, Toyota’s Prius, etc.) which provide exactly the type of cars the Chinese government is trying to push with its NEV (new engery vehicle) initiatives. Chinese customers and government, however, are reluctant to take advantage of this mainly due to the political tensions with Japan.

Japan, similarly, is struggling to become independent of China’s economy. In particular, it significantly raises costs for Japanese companies. One example are rare earth metals. China produces more than 95 percent of the world’s rare earth metals. Rare earth metals are essential to the production of hybrid and electric vehicles. Hence, it comes as no surprise that Japan accounts for a third of global rare earth demand. While Toyota developed a way to produce those cares without rare earth metals it increased the costs for engine significantly.

While the recent development gives hope that further escalation might be averted it is likely that this changes as soon as both countries do better economically.

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