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.


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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Singapore’s Lee Kwan Yew and the pragmatic approach to governance

In the foreword to “Lee Kwan Yew: The Grand Master’s Insights on China, the United States, and the World”, Henry Kissinger said “I have had the privilege of meeting many world leaders over the past half-century; none, however, has taught me more than Lee Kwan Yew.” Often referred to as the founding father of Singapore, Lee Kwan Yew has led the small, backward fishing village with virtually no natural resource into a first-world nation in a single generation, earning himself a reputation as “the man who saw tomorrow.” Mr. Lee has served both as mentor to Chinese leaders and counselor to American presidents. However, his views and insights are far from diplomatic. In fact, his frankness often draws controversial views and opinions. Among this was Mr. Lee’s self-claimed pragmatic approach to governance.

LKY with ObamaLKY with Hu Jintao

In August 2007, Leonard M. Apcar, deputy managing editor of the International Herald Tribune had an interview with Mr. Lee. The interview focused on understanding the Singapore’s extraordinary growth and also Mr. Lee’s assessment of the broader political landscape, China, Southeast Asia, Japan and the United States. Excerpts of this interview can be found in the following link (Credit: The New York Times).

While debates have been going on about the superiority of the Western democracy versus the Eastern communism and authoritarian, and discussions have been speculating about the possible future of a more liberal democratic Singapore, what stood out to me is Mr. Lee’s outright pragmatism when talking about Singapore’s growth and its future. In the interview, Mr. Lee agreed to the importance of marketplace stimulus to the growth of the economy, however, he also stressed the importance of pragmatism towards opening up of society, loosening of the press, of free speech, of political competition.

In addressing free speech, Mr. Lee said “For the top 20 percent of the population, there are no constraints there. They’re educated abroad, at university. So, they know the wide world and they are on the Internet and they’ve got friends, they e-mail them. They travel. Every year, about 50 percent of Singaporeans travel by air. So, this is not a closed society. But at the same time, we try to maintain a certain balance with the people who are not finding it so comfortable to suddenly find the world changed, their world, their sense of place, their sense of position in society. We call them the heartlanders…”

I see this practical approach making a lot more sense for developing economies as a transition model rather than a direct Eastern communism/authoritarian or a Western democracy. Studying the case of Special Economic Zones in India by Laura Alfaro and Laksmi Iyer, while the SEZs are important stimulus to India’s economic growth, the democratic government met with strong resistance from its people. The case of public purpose versus property right hinted at the apparent gap between the level of development of the country’s political liberty and the level of education and openess of a population with over 1 billion people. Successful cases of implementing SEZs have also been seen in economies where the government could take more assertive actions overriding individual’s interest i.e. China, South Korea and Singapore.

In the discussion paper “Which capitalism? Lessons from the East Asian Crisis”, Raghuram G. Rajan and Luigi Zingales talked about the differences between a relationship-based system versus an arm’s length system. One of the conclusions was the importance of establishing a strong contractibility system to support to influx of capital, otherwise a high capital with low contractibility could lead to what we’ve seen at the 1997 Asian financial crisis. This study highlighted the importance of maintaining control (in this case, of capital inflow) while closing the gap of internal infrastructure development.

While Mr. Lee has attributed much of his approach to governance to understanding the Asian values, I see his governance as a pragmatic approach maintained through strong government control. For developing economies where the level of education of its population lags behind that of developed nations, a strong government is important to take the lead and direct economic policies that are vital to the public purpose at large. Where internal infrastructures are still being put into place, a strong government is important to moderate the opening up of the economies to prevent an influx beyond what it can sustain.

However, we must also recognize that this is a transition model. There would be that tipping point where the government needs to slowly let go of its control and empower its more educated generation, placing trust in the developed internal infrastructures to keep the development in place. As in the case with South Korea, the model of using large conglomerates to lead the industrial development was important when the government needed strong business leaders to lead the economy. However, 1997 Asian financial crisis was a tipping point where over-reliance on these conglomerates could do harm to the economy. A transition of power and control to the rest of the population is important to sustainable economic growth.


Which Capitalism? Lessons from the East Asian Crisis – Raghuram G. Rajan and Luigi Zingales, University of Chicago
Special Economic Zones in India: Public Purpose and Private Property – Laura Alfaro and Lakshmi Iyer (Harvard Business School case)
Daewoo and Korean Chaebols – Elyssa Tran (Centre for Asian Business Cases)

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The New Silk Road Strategy – China’s real answer to the TPP?

Chinese interest in the Russia-Kazakhstan spaceport feud

Picture 1: Soyuz – will it stay or will it go? (Source:

Back in the day, manned Soyuz mission into space sent shivers through observers. Russia’s main spaceport, Roscosmos, then in Soviet Union and now based in Baikonur in central Kazakhstan, has a stirring record of blasting off Sputnik, Laika in the 1950s, and Yuri Gagarin in 1961. Today, Roscosmos still launches most of its rockets from Baikonur, about 22 -25 times each year, and in turn pays about $115m a year to lease the remote chunk of prairie. Currently, the Soyuz is the only way to get people to the 15-nation International Space Station.

But Kazakhstan and its tenant are bickering. The chief of the Kazakh space agency, Kazcosmos, has threatened to tear up the lease. Russia, in turn, is building a new spaceport on its own territory, threatening to make the cosmodrome redundant. And China, generally uninterested in the political or ideological agenda of other countries, is now taking keen interest in resolving this standoff between former Soviet Union members. Why?

China courts Central Asia

The answer lies in China’s multibillion-dollar plans for a land based “New Silk Road”. As Chinese manufacturers move inland, getting their products to European markets has become more complex. The journey back to the coast and halfway around the world by sea takes up to 60 days, an eternity for fast fashion products. As shown in Picture 2, both Kaszakstan and Russia provide that much-needed backdoor route. Trains from Chongqing in south-west China to Duisburg in Germany, 10,800 km (6,700 miles) via Kazakhstan, Russia, Belarus and Poland, supposedly take just 14 days. Kazakhstan’s state-run railway, KTZ, promises to spend $44 billion over the next five years to make that 10 days. On Nov. 8, Chinese President Xi Jinping announced the establishment of a $40 billion Silk Road infrastructure fund, focusing on building “roads, railways, ports and airports across Central Asia and South Asia,” according to Reuters.

Picture 3: Land and sea based Silk Routes (Source:

The land based silk route complements China attempt to dominate the sea based maritime route (Picture 3), which may even extend to the Panama Canal as highlighted in my previous blog, “Chinese waterway in Central America”, (dated October 25, 2014).

New Silk Route – Chinese response to TPP?

The United States is promoting the Trans-Pacific Partnership (TPP), a massive free trade agreement including 12 nations, excluding China. Proponents of the TPP see it as a new vision for free trade and market liberalization around the world. It would integrate the U.S. economy with Asia to a degree so far unseen, providing a backbone for the U.S. amalgamation to Asia. In doing so, it would set higher standards for doing business, with clauses intended to protect both the rights of workers and the environment. It may even become more authoritative than the WTO, which currently sets the norms for international trade. It also addresses some of the hot-button issues like subsidies to the agricultural sector, manufacturing of parts and components, trade in services, and intellectual property rights protections, which the WTO is silent on.

Certain Washington insiders believe that the TPP could lead to one of two responses from China, both of which are potentially advantageous to U.S. interests: the TPP’s stringent labor and environmental standards would deter China, eliminating itself out of a huge and beneficial trading block in its own backyard. Or, China would request to join, and in the process become a more economically open nation.


Firstly, there seem to be little evidence that China would adhere to any of these expectations. From the Chinese perspective, the Silk Road strategy is a far better fit for Beijing than the TPP. With the TPP, the US emphasizes high standards in market liberalization and openness, and seeks to reduce the roles of governments in market operations and to restrict the importance of state-owned enterprises (SOEs) in the economies of its members. China’s Silk Road strategy does not have explicit “standards,” except for a vague idea of mutual interest and mutual respect. In addition, it relies on top-level government coordination, and would enhance the power of large SOEs and governments. The TPP focuses on services, intellectual property rights, and domestic regulations. The Silk Road strategy aims to facilitate large-scale infrastructure construction, energy sale and transport, and relocation of manufacturing industries.

Secondly, as China seeks to establish itself as an economic and institutional equal to the US, it is inevitable that Beijing will have to take on a more active involvement in regional diplomacy. Relationship among countries in the New Silk route is shaky, as most are embroiled in ethnic, political and economic conflicts. Hence China will have to consider leading the pursuit of regional peace with as much vigor as it does its economical quest, if the country intends to not just attain, but also to sustain its vision as an expanding world power.



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Thanksgiving for the Whole OPEC Family

This Thursday, or Thanksgiving for those readers currently in the United States, marks more than a day to give thanks for what we have and eat until we sleep: it is the much-anticipated meeting of the Organization of Petroleum Exporting Countries (OPEC). Although all OPEC meetings are anticipated, as this is where the cartel determines changes in oil production that will affect global supply, this particular meeting is special.

Since this past June, oil prices have dropped almost 30% of their prices, peaking at 115$/barrel but currently trading at roughly 80$/barrel. At this meeting, OPEC will determine if changes in production need to be made in order to curtail the declining price or if they will continue the same level of production.

Why is the price of oil so important? Obviously, as one of the key inputs for transportation and machinery, it plays a big role for any country invested in these industries. Many East Asian countries, such as China, import their oil primarily from OPEC countries. As a result, the price of oil has a direct effect on East Asian countries. What OPEC decides to do with oil production will have an immediate impact on these countries, as well as their future growth potential.

So the real question becomes: Will OPEC actually decrease production in order to halt the falling price of oil? Personally, I feel OPEC will decide to continue the same production of oil and will do some in the foreseeable future. According to oil experts, OPEC will need to curb production by at least 3% (or 1M barrels/day) in order to bring supplies closer to demand. However, OPEC does not operate under normal business rules; they are a cartel who closely controls oil output, led by the largest producer Saudi Arabia. The majority of these oil production cuts will have to come from Saudi Arabia, and if they do not feel it is in their best interest, the rest of the OPEC members will follow suit. Other countries, such as Iraq, have mentioned that the unity of OPEC is more important than immediately changing oil production.

opec breakdown

However, some investors are cautiously awaiting OPEC’s decision. John Kilduff, a founding partner at Again Capital in NYC, has entirely removed himself from the oil market until the meeting is completed. Tariq Zahir, managing director of Tyche Capital Advisors, has only about one-fifth of the usual exposure in the oil market. According to him, any changes in output will either never occur or simply be symbolic, as Saudi officials have signaled that the production is unlikely to change. The options and futures contracts on the Nymex market outstanding fell by 13%, reflecting Zahir and Kilduff’s fear in the uncertain oil market.

If a nearly 30% price drop isn’t enough, at what price would OPEC decide “enough is enough” and finally change production? According to one OPEC official, 70$/barrel will lead to a panic in OPEC and result in reactive measures. As of now, the price is 80$/barrel, which according to the OPEC Secretary General Abdalla Salem el-Badri, “is concerning, but not yet a panic.” Most OPEC officials are on the record as saying that they don’t expect the price to drop below 75$/barrel, in which case no action will be necessary.

opec leaders meeting

*OPEC Leaders decisively deciding to do nothing

So where does that leave us? Well, if all goes as planned, the decline in oil prices will achieve a valley before hitting 70$/barrel, OPEC will do nothing to change their production, and investors will become more confident in the oil market in the weeks following OPEC’s meeting. If this were not the case and prices continued to decline, however, OPEC is going to need to make some major decisions. Given that many countries in OPEC rely on high oil prices to help balance their budget, those decisions will need to happen fast.


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Careful Research Necessary to Uncover India’s Best Investment Opportunities

By: Ben Sirois

India’s past rapid economic growth and newly elected government with a focus on economic liberalization and the economy seem to make India a prime country to invest in. However, the opportunity in India is not uniform within states, districts, cities, and even towns. Careful research will be necessary to pin point what locales offer the best conditions for business investment.

There is a promising story in the economic data. Historic growth has been high and annual GDP growth rates are expected to average between 6.4% and 7.7% until 2025. This puts India as one of the fastest growing and large economies. However, this potential varies greatly from region to region. According to a McKinsey & Company report more than half of GDP growth between today and 2025 will come from just eight states. These regions are: Gujarat, Haryana, Himachal Pradesh, Kerala, Maharashtra, Tamil Nadu, Andhra Pradesh, and Uttarakhand.


The areas account for only 31% of India’s population, however they will be home to 57% of the country’s middle-class households. There are indications that per capita GDP could grow twice as fast in its highest-performing region compared to the national average. According to Madgavkar and Mohan, these regions will have economies that resemble middle-income countries.

The weakest states, including Bihar, Uttar Pradesh, and Jharkhand have per capita income under 0.7 times the national average. Without rapid change in governance and investment strategy these areas will continue to face low incomes and high population growth. However, business investors need to look deeper than headline data announcements in identifying wise places to put their money. Specifically, certain urban clusters have massive potential. Madgavkar and Mohan identified 49 high-growth clusters. These areas held half of India’s population, 70% of GDP, and 71% of middle-income consumers.

Surprisingly, a third of these clusters are in states that have had low to medium economic growth. These various clusters have an array of industries located within them. The Nellore cluster in Andhra Pradesh is highly agricultural with paddy, tobacco, groundnut, mango, and sugarcane farms while the Bikaner cluster in Rajasthan is rich in quarrying marble and limestone.

These lesser-known clusters emphasize the point that future investors ought to look very carefully at India’s economic geography. These locales could become the knowledge-based industrial or service hubs of the future. These clusters would generate some of the best returns and ought to be getting a lot more of attention from foreign investors.

1) “Understanding India’s economic geography,”

2) Anu Madgavkar and Rakesh Mohan, “India’s Economic Hotspots”

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Does the Rich Get Richer and the Poor Get Poorer from Abenomics?

Mr. Abe

The Prime Minister Abe explaining his three arrows of the economic policy, Abenomics

three arrows

During a past few months, Japan has been experiencing the huge changes in the market price and great depreciation of yen.

Abenomics is undoubtedly the hottest controversial topic over the Japanese economy. While people who actually get the benefit and feel that Japan starts recovering its economy support his policy, there are also people who do not get any gain and criticize his policy. Even so, the new reform has been showing its positive effect at least in the increased revenue of major Japanese corporations such as Toyota, and both domestic and foreign economists gave the positive future prospects on Japanese economy. However, last week, it was announced that GDP during the third quarter of this year was unexpectedly shrank by 1.6%. Since it was far behind from the expected GDP growth, Abenomics is called into a big question again. Then finally, the Prime Minister Abe announced that he will dissolve the lower house of parliament and will have the election in a month to ask people whether they still agree with his policy and  the decision about the postponing of the second stage of tax reform.

Japan is facing the time to give a decision on Abenomics.

The biggest controversial point is that Abenomics makes the gap between the rich and the poor bigger so that the rich people tend to support the reform while the poor do not. Is this true? And if it is true then should Japan stop continuing Abenomics reform?

I think it is true that the rich people likely to get the direct benefit and the poor still haven’t got the direct gain from Abenomics. For example, Toyota, the biggest Japanese automobile firm has announced that the revenue for this year will record the biggest-ever launch because of the growth in export. However, at the same time, many of the subcontract factories of Toyota are having difficult moment since the import material cost is increasing as yen becomes weaker. In addition, the increase in the consumption tax, one of the main reforms of Abenomics, usually is a heavier burden to the people whose income is lower. From these points, it might be true that Abenomics has unequally benefitted to the rich and the poor at this point.

Nevertheless, personally, even it makes smaller effect on some people and the great depreciation of yen makes my life in the States much more expensive, I still believe that the recovery of Japanese corporations is the big and important first step to get out of the Japanese lost decades.

Japan has been struggling in the deflationary spiral for decades. Since people expect the deflation, the consumption falls. Because the consumption falls, the revenue of companies falls so the people’s income drops. In order to get out of this bad spiral, the company needs to recover first and then wage will increase so the income level will increase. Then people will start using more money. I think Japan is right now at the first stage where the company begins to perform better. So they next need to raise the wage. Mr. Abe just had a meeting with the Japan Federation of Economic Organizations and asked them to agree with the increase in the wage from the next spring and it is expected that they will sign the consensus document before the end of the year. The consensus also will include some structural reforms such as lowering the corporate tax and easing of regulations. The government hopes this will stimulate the consumption to increase.

As discussed in class, Japan also has many problems in the long term such as the lack of labor force, nuclear plant, or education, and the third arrow of Abenomics does not show the specific action to each problem. However, I think that at least the reform helps Japanese economy to get out of the long recession gradually, and many people are still expecting the positive result from Abenomics.

The next month election will reveal the people’s evaluation on Abenomics up to this point.

deflationary spiral

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The effects of Japanese slowdown on India

Between April and September, Japan,the world’s third-largest economy registered successive quarters of shrinking GDP. Japan has entered a recession. Even before this data was released, the Bank of Japan (BoJ) announced it would increase Quantitative Expansion(QE). The announcement pushed the yen to a seven-year low against the dollar. Japan has seen very low growth and deflation for the last two decades inspite of trying. It multiple QEs. Also, there has been massive deficit financing of infrastructure capacity. Government debt is a whopping 250% of its GDP.  At two per cent levels, inflation would stimulate consumption demand; the QE is designed to target that two per cent. Economists say the recession should be short-lived and a recovery could happen as early as the next quarter.

How will this affect India and, in a broader sense, the rest of the world? India and Japan have a comprehensive economic partnership agreement. In 2012-13, bilateral trade stood at $18-19 billion, falling to $16 billion in 2013-14, as both the rupee and the yen declined against the dollar. Since 2000, private foreign direct investment (FDI) from Japan has been $15-16 billion.


With the Narendra Modi government in the saddle, the mood in the corporate world has changed dramatically. The optimism has seeped beyond borders and is perhaps most palpable in Japan. Warm political ties and a great personal rapport between the two country heads, Shinzo Abe and Modi, offer great opportunities for a thriving economic relationship. Japan is expected to play a big role in some of the biggest projects of the Modi government, from the $90-billion Delhi-Mumbai Industrial Corridor to bullet trains, metros and industrial parks. Investments from Japanese firms across the board — Nissan, Toyota, Mitsui, Honda, Uniqlo et al — are expected to surge

Prime Minister Narendra Modi’s visit to Japan in September led to FDI commitments amounting to about $35 billion through the next five years.

As Japanese exports (to India and the world) are likely to rise due to a weaker yen, Japan could get a larger share of global trade. This might induce China, Korea, Thailand, etc, to weaken their respective currencies. Japanese FDI flows into India could fall below the estimated $35 billion, as the yen has fallen substantially and is expected to remain weak for an extended period. So long as QE continues, the yen will trend weaker. Borrowing in yen and buying risky assets in any other currency will be attractive. The yen carry trade could mean a lot of money flowing into Indian equities and other assets. There is a point at which the yen will snap back or, more likely, see many recoveries between net losses. Being net-short on the yen against any other currency might be profitable. In strictly local terms, Indian markets are valued somewhat higher than the fundamentals seem to warrant. But the consensus about future performance is optimistic. For a foreign institutional investor interested in yen carry trades, India is an obvious destination. The market is big enough to absorb large investments and has relatively high growth rates compared to peers.

Also, India is out of step with many other large economies. It could be a haven in 2015, which promises to be a year of low global GDP growth. Though the US is pulling out of recession, China, Europe and Japan remain weak, while Russia is struggling. Among other emerging markets, Indonesia is weakening amid higher inflation, while Brazil and South Africa are amid woes. India, on the other hand, has higher GDP growth and lower inflation. Though the Indian economy has many problems, 2015 could be better than the past three years. The BoJ’s decision to expand QE might ensure Indian stock markets remain buoyant.

An interesting aspect is the asset allocation patterns in Japan. That country has seen zero or near-zero interest rates for a long time. Under these circumstances, conventional wisdom indicates a rise in consumption and a shift in asset allocation from debt to equity.

But Japan has an ageing workforce and a large retiree population. Household savings patterns remain debt-oriented and consumption hasn’t increased. Though a stock market recovery has been seen, it has not translated into wealth effects and increased consumption. Few individuals hold substantial equity. For 20 years, the stock market headed nowhere, and this has created permanent aversion.

This makes for a very interesting comparision. India has very different economic conditions, demographics and stock market performance. But Indian household savings and asset allocation patterns seem to be as equity-averse as Japan. The underlying reasons for India being equity-averse might include lack of trust. While the stock market has given stellar returns, it has also seen periodic scams and scandals. Many retail investors lost money when they were caught in these, leading to their family/friends also turning equity-averse. It will take time before this changes.


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