The Odd Couple: the Clash and Interdependence between Japan and China

The Odd Couple: the Clash and Interdependence between Japan and China Hiro Ito Associate Professor of Economics Portland State University “Trade Prospects and Problems in 2013,�

Global Independence Center Conference, January 15, 2013

The Odd Couple • China and Japan, the world’s 2nd and 3rd largest economies, are in the worst diplomatic relationship since the end of WWII • Economically, these two countries are so interdependent on each other • The interdependency is a reflection of each economy’s medium-run trend • The prospects of these economies are dependent on how they deal with their own medium-run issues as well as how these countries decide to behave to each other

The Territorial Disputes between Japan and China?

Economics of the Senkaku (尖閣) /Diaoyu (钓鱼） Disputes • On Sept. 11, GOJ nationalizes the three islands • Followed by massive protests all over China “Rocks”?

Senkaku（尖閣）/Diaoyu（钓鱼） Islands

o The diplomatic relationship is worst in post-WWII era o Even some possibility of military conflicts

Not only are they big, but also they are intertwined

China is the largest trading partner for Japan; Japan is the (close) second largest exporter to China

Structural Issues Facing the Two Countries

Income inequality is one of the biggest issues for China • China’s Gini index is 0.42, even higher than that of the U.S. (.38), getting closer to the level of L. American countries • Economic liberalization policies since the 1980s has made people in the coastal region and urban areas richer disproportionally to those in the inland region and rural areas

The Chinese Development Model and “Latin Americanization”  A smaller portion of econ growth goes to the hands of people – the proportion of labor income to the total income, i.e., GDP, has been shrinking  A large portion of income growth is being recycled in the form of investment (45% of GDP)  “Capitalists,” those with assets to invest, and those w/ connections to the gov’t would benefit  As the state-related employment shrank, so did social protection provided by the government. No more cradle-tograve care  State-owned enterprises are becoming influential again, benefiting certain business people and party officials

Economically Disadvantaged and Angry Migrant Workers（农民工）  Engaged in manufacturing jobs in the urban areas with discriminated wage levels  Not entitled to receive social protection available for urban residents due to “Huko” (戸口) system  Often become violent to have their voice to be heard and win wage increases  Recently, winning large wage increases though it is essentially self-defeating  making themselves too expensive  “Dry grass in the prairie”

Extremely Severe Environment for Japanese Economy • Japan has been experiencing the “Lost Decades” Long-run trend • Aging and shrinking population = Shrinkage of labor population as well as of domestic markets • Yen on the long-run appreciation trend • Increasing labor cost + “hollowing out” of industries Post-Global Financial Crisis • Exacerbation of Yen appreciation Post-triple (Earthquake/Nuclear/Tsunami) crisis • Energy shortage

J. Yen per US Dollar, 1992 – 2012

Currency Depreciation

Real effective exchange rate, Aug. 2008 = 100

• The Japanese yen has appreciated significantly since 2008 • Nominally, 25% against the dollar • In real sense (i.e., adjusting for inflation), by 40% against Japan’s trading partners (cf.

10% for CNY, -10% of KRW)

GFC Hit Japan so Hard, so did the “Triple Crisis” Profitability of J-firms

• J’s manufacturing sector got hit so hard by GFC • Auto sector got hit harder • Manufacturing firms need to do: – Reduce production cost – Find new promising markets

• The solution is … look toward Asia, esp. China

Japan increased FDI in 2011 • Japan doubled outward FDI • Japan’s FDI to China increased (in values) by 74% in 2011 • J-firms used to focus on China’s cheap labor force, • But now, they focus more on the rapidly growing consumer markets in China

Both economies started slowing down • But mainly due to the EU economies’ slow down – EU is China’s largest trading partner – EU is Japan’s third largest trading partner – As China slows down, it helps Japan slow down

ST Risk of China 1. Social stability – How can Xi Jinping’s government maintain?  <old social contract> “Rulers would ensure prosperity so long as the ruled did not demand too much freedom”  The old social contract no longer holds  People want both prosperity and freedom  Income gaps are at an unacceptable level  So are corruptions  The new regime will succeed Hu Jintao’s efforts to create a “harmonious society,” i.e., strengthen social protection  However, little is known regarding how actively the new leadership pursue reforms  Are the rulers also Latin Americanized?

ST Risk of China 2. Rise in the labor cost, which may feed social unrest  <Previously> Slow growth in wages but rapid growth in productivity  profits for the firms  <Now> Wages rising faster but productivity starting to plateau  Chinese workers are getting more expensive  “Middle-income trap”  Shrinkage of the manufacturing sector is due to occur

Japan’s ST Uncertainties  The biggest uncertainty continues to be its politics  Is the “new LDP” any different from the “old LDP”?  When will the country restore political stability and credibility?  Can “Abenomics” stop deflation?

– Abe’s gov’t will implement a massive Keynesian stimulus policy despite the debt concerns – Abe will push BoJ to target a higher rate of inflation (= 2%)

Given these circumstances, the Bottom Line is …

The Two Countries Need Each Other!!

• Japan needs China’s labor force and wants access to the vast markets in China • China needs Japan’s technology

Interdependency May Have Been the Cause of the Clash, because â&#x20AC;˘ Both countries know they need each other But, hopefully, â&#x20AC;˘ It may also help prevent the current situation from worsening because of that

After all, economics is not everything • Both countries just started new gov’ts • Military conflicts are not impossible

Thank you! ありがとうございました 非常感謝