China in Transition

The Vitality of China-related Businesses - "China Syndrome" draws to an end as Japan's economy recovers

Chi Hung KWAN Consulting Fellow, RIETI

There had been concerns in Japan that the rise in Japanese direct investment in China and imports from China would exacerbate deflation in the domestic economy and lead to a hollowing out of industry. However, as it becomes clearer that the Japanese economy is on a recovery path, and that one factor supporting the economy is exports to China, we are beginning to see an end to the so-called "China Syndrome" - the perception that China is a threat to Japan - which had at one time been prominent, as well as an end to demands for the yuan's appreciation, which was symbolic of this mentality.

After a lost decade, the Japanese economy is finally beginning to emerge from the long tunnel of recession. The economy grew a quarter-on-quarter 2.2 percentage points during the July-September period of 2003 - the seventh straight quarter of positive growth. In line with economic recovery, unemployment has fallen from 5.5% at the beginning of the year to 5.1% in September, and corporate earnings are improving. Coupled with the fact that fears of a financial crisis have receded, stock prices, which in the spring of 2003 fell to their lowest level since the collapse of the bubble economy, are recovering.

The engine for this economic recovery is private capital investment and exports. Surging exports to China, especially, are making a huge contribution to the rise in total exports, since exports to the United States and Europe remain flat. According to Japanese customs statistics, exports to China for the January-September period grew by 43.9% in dollar terms on a year-on-year basis, much higher than the 21.9 percentage point rise in imports from China during the same period. Thanks to increasing investment, the Chinese economy is growing, and demand is rising for machinery and chemical products - areas that are Japan's forte. Reflecting the fact that China-bound exports are growing much faster than imports from China, Japan's trade deficit with China, which had been on the rise, has been falling since 2002. China has already become Japan's No.1 partner in terms of imports and is the second largest absorber of Japan's exports after the United States.

In addition to trade, Japanese foreign direct investment in China is on the rise. According to Chinese statistics, Japanese direct investment in China during the January-September period came to $3.67 billion on an implementation basis, a pace that may break the full-year record of $4.35 billion set in 2001. The business operations of Japanese firms that have already made their foray into China are also getting on track. According to the "Survey Report on Overseas Business Operations by Japanese Manufacturing Companies - Results of the JBIC FY2003 Survey on the Outlook for Japanese Foreign Direct Investment" by the Japan Bank for International Cooperation Research Institute for Development and Finance (November 2003), satisfaction with both profitability and sales of operations in China have risen sharply as production facilities have started operating at full-scale. Due to factors such as the growth potential of the market and cheap labor and other inputs, 93% of the firms responding to the survey (manufacturers with at least three overseas affiliates) said they believe their business in China has the potential to grow in the midterm (the coming three years or so), and among them 70.8% said they have specific plans to expand their operations in China.

Amid such an environment, we are beginning to see a change in public opinion over the yuan issue which was symbolic of Japan's China Syndrome. According to the results of a Nihon Keizai Shimbun questionnaire survey of major Japanese firms conducted in early September that appeared in its Sept. 20 edition, 37% of respondents said that an appreciation of the yuan would have a negative impact on their business. This figure was much larger than the 16% of respondents who replied that such a situation would have a positive effect (table). The appreciation of the yuan would certainly improve the international competitiveness of some Japanese products, leading to increased sales not only in the Chinese market but also in third-country markets. However, on the other hand, many firms that outsource products and parts from China (including those which procure from their own manufacturing bases) are concerned that a stronger yuan will lead to a rise in the import prices of Chinese goods and push up production costs.

As this shows, finally there has come to be a wider understanding of our consistent assertion that, reflecting the fact that Japan and China are in a complementary rather than competitive relationship, China's advancement provides the perfect opportunity for Japan to improve its own economy; and a stronger yuan has more demerits than merits for Japan.

Table: Effects of a stronger yuan on Japanese companies
Positive (16%)A rise in exports to China can be expected
The competitiveness of Chinese products will decline
The value of our yuan holdings will rise
More or less neutral (47%)The scale of our China-related business is small
Our imports from and exports to China are balanced in value terms
We have the ability to absorb currency rate fluctuations
Negative (37%)Prices of imports from China will rise
The competitiveness of our production facilities in China will decline
The cost of Japanese staff in China will rise
A strong yuan may have a dampening effect on the Chinese economy
(Sourse): Nihon Keizai Shimbun (Sept. 20, 2003)
November 21, 2003

November 21, 2003