What Do Surging Exports to China Implicate?

Senior Fellow, RIETI

With a strained smile, a journalist said, "I suppose we will now have to report on our economic recovery as being dependent on both China and the U.S." He was alluding to the remarkable increase in Japanese exports to China.
Graph 1 compares the monthly growth of Japan's total exports with exports to China in 2003, by which one can easily see it is exports to China that has led the overall rise in Japan's exports. According to Japan's latest trade statistics for January - October of 2003, exports to China have reached 5.41 trillion yen. When one considers that the figure was only 2.62 trillion yen in the same period of 2000, one realizes that it has doubled in just three years. Many sectors of the Japanese economy, from the raw materials industry including steel and chemicals, to consumables such as household electronics and mobile phones, and even construction equipment are benefiting from China's rapid economic growth.

In the first half of this fiscal year, for instance, exports to China and Hong Kong (an approximation of actual exports to China) were valued at 5.07 trillion yen, equivalent to 75% of exports to the U.S. (6.69 trillion yen). If we include exports to Taiwan, whose economy is merging with mainland China more rapidly than Japan, the figure for exports to "greater China" reaches 6.79 trillion yen - already exceeding the figure to the U.S. If current trends continue, exports to China and Hong Kong should also come to exceed those to the U.S. within two or three years, should the current pace of growth be maintained. These figures suggest that we are on the threshold of a historic change in our main export markets.

At present, Japan must, in effect, have a clear export surplus with China. (Even according to the official statistics, Japan's trade surplus with China and Hong Kong for the first half of this fiscal year was 881.9 billion yen.) Suppose this had happened ten years ago, the Chinese leaders would definitely have expressed concerns over such a growing trade deficit. Why do they not dare do so today? China dare not say anything, supposedly, because neighboring countries perceive it as an "economic threat," and not causing a stir might help mitigate such concerns.
As a consequence, Japan's view of China is also changing. The "China economic threat" theory that was circulating two years ago has substantially subsided, at least among large enterprises. China's long-standing insistence of the mutual economic complementarities between Japan and China is resuming a sense of realness, and China is becoming a graceful benefactor in the minds of businesspeople.

East Asian economic integration: gradually taking shape

Reflecting on the aforementioned economic climate, let me remark on three matters.
First, East Asian economic integration is beginning to become a reality (see graph 2). As a result of the rapid growth of the Chinese economy, particularly on its demand side, not only is industrial division of labor deepening within the region, but a mutual interdependency is also deepening in terms of final demand. According to recent surveys conducted by the Japan Center for Economic Research and the Ministry of Economy, Trade and Industry, Japanese businesses have increased their calls for a broader-based free trade agreement (FTA) among East Asian countries (such as ASEAN+3), which surely reflects the actual changes occurring in the regional economy.
No doubt, Japan needs to open up its agricultural market in order to achieve FTAs with East Asian countries. It is particularly clear that cosmetic reform is far from enough for achieving FTAs with Thailand or China. Kazuhito Yamashita, a Senior Fellow of RIETI, recently called for drastic changes in agricultural policy to ensure the survival of the agricultural sector in an FTA era, and the necessity for the measures he recommends appears more pressing with each passing day.
Second, the currency issue matters. Real economy - such as trade and investment - is inseparable from other sides of the economy; money and currency. If we are to plan FTA policy for the real economy, we also need to plan regional cooperation in terms of currency and money. Unless both sides advance in tandem, the vulnerability of the regional economy will increase.
Although at one time calls were heard in Japan for the appreciation of the Chinese yuan, leaders of Japanese industries have recently been calling, one after the other, for a stable yuan rather than a stronger yuan. They seem to have noticed the consequences that large and frequent fluctuations in the yuan/yen exchange rate can have on their business. While the current demand/supply situation in the Chinese FOREX market suggests that yuan appreciation is inevitable sooner or later, such an adjustment does not necessarily mean that a free floating yuan is the optimal policy.
China's current policy of pegging the yuan to the U.S. dollar will continue to lose its ground as mutual interdependence increases in the regional economy. Business predictability for Japanese industries would be greatly enhanced if the yuan floated in a range between the dollar and the yen, if the yuan is not pegged to the yen. It has become clearer that China hopes to stabilize the yuan. To this end, China should adopt a currency basket framework with which it can draw a target for exchange rate stabilization. Countries in the region should also cooperate with China in this stabilization. Doing so would be of benefit to both sides. As FTA discussions advance, it is necessary to keep the importance of future currency cooperation in mind.

The widening gap between "winners" and "losers"

Third, the gap between those benefiting from China and those suffering from China ("winners" and "losers") is becoming increasingly wider and more contrast. While big companies are enjoying business in China, few such chances are given to small and medium-sized enterprises (SMEs) because of their limited business resources. Rather, they are facing serious difficulties as more and more customers relocate facilities to China, and domestic orders decrease as a result. This tendency is especially noticeable among subcontractors who do not produce their own products.
Such a widening of the gap might be unavoidable when economic transformation takes place so rapidly. However, a distressing schism in a country should be avoided if there is any way to abate the number of victims of such transformation.
There is a glimmer of hope. The Chinese business community has long argued that manufacturing products in high-cost Japan is meaningless. But as business exchange deepens, at least some people seem to have slightly changed their minds. They say that the factories themselves are not necessarily responsible for the high-cost, rather, company sections like procurement or sales, which are the major sources of unnecessary overhead, is where the blame lies. In fact, the factories still running in Japan are amazing because the product line is much diversified, the manufacturing method is very flexible, and despite all this, employees are surprisingly few!
Some in the Chinese business community have become curious about acquiring Japanese firms with advanced technologies. They don't mean to take the production equipment and technological assets away to China, but want to achieve satisfactory returns, above the acquisition price, from the Japanese plants.
About two years ago, for example, a Shanghai-based company acquired a bankrupt medium-sized company in Tokyo which produces industrial printing machinery. The Chinese side successfully reduced unnecessary costs and increased their sales, in particular, export to China. The acquisition succeeded! Moreover, when I recently met with someone quite familiar with the case, he said, "After purchasing the company, we checked all the parts and materials that had been bought. Although we found many which are too expensive and are therefore not worth purchasing in Japan, we also found many that are only available in Japan."
Upon hearing this I wondered, if China wishes to avoid complaints from neighbors about an economic threat, might it be possible not only to purchase Japanese companies, but also to order parts, materials, and other goods that can only be produced in Japan, in order to increase exports to China from Japanese SMEs?
The greatest obstacle to realizing this idea is the lack of a platform (and personal relationships) by which such orders can be delivered between Japan and China. Over the past several years, a lot of skilled workers who quit (or were forced to quit) jobs in Japan moved to China and served as technical advisers to local firms. While these trends are currently viewed as a loophole of technology outflow, let us look on the bright side. Could these technical advisers not serve as brokers for cross-border transactions in parts and materials? Once they have gained knowledge of local conditions, they could do this because they are quite familiar with suppliers in Japan. Exchange students who have jobs in Japan could also be sent to China to assist in sales. I would like to see the creation of such procurement channels. They would help forge new economic links between Japan and China, and boost the number of SMEs with close ties to and serving as regular suppliers to Chinese firms.

December 9, 2003

December 9, 2003