The energy crisis arising from the military conflict surrounding Iran has further deepened the external threats facing Japan, bringing economic security sharply back into focus. Yet what deserves attention goes beyond energy security alone. Defensive policies driven by economic anxiety, and a passive economic diplomacy, may—if left unchecked—deepen the very challenges Japan faces.
While the liberal international order has been undermined and key assumptions that enabled Japan's post-war economic ascent have been upended, the fundamental principles that underwrote that success endure.
Even in a more hostile external environment, openness and integration into the global economy are central to Japan’s prosperity and economic security.
If Japan’s economic security policies consist mostly of defensive measures that increase costs for business in the name of security and become a driver of runaway industrial subsidies, Japan will be poorer and likely much less secure.
Openness backed by a proactive economic diplomacy is still the strategy for prosperity and security, even though there has been a deterioration of the global rules based economic order. In the 1930s, the last time there was a serious breakdown in the global economic order, Japan’s growth outpaced other major economies because of its macroeconomic management and because it stayed relatively open even as other markets closed.
Today, Japan is faced with two Great Powers who have weaponised trade. The United States is threatening the rules-based economic order that has underpinned stability and security for the past three-quarters of a century. China has become a major competitor to Japanese industry, using industrial subsidies to help it dominate some sectors globally and abusing its market power for political leverage.
Japan is not alone in this predicament. Canadian Prime Minister Mark Carney declared at Davos that the myth of the rules-based order is over, outlining the start of a strategy for middle powers to work in concert to find their way in the new world. His claim that the rules-based economic order was a myth and that it is now dead anyway, is news to most of Asia that still relies on it. In Europe some are worried about what they will sell to China in the future since it seems to have competitiveness in everything that Europe makes. Chinese industry now produces more than the United States, Germany, Japan, India and the next top six countries combined.
China’s mercantilist policies are an existential threat to European, Japanese and American industry, according to that narrative. Unfair competition from the “China Shock 2.0” has led the European Union and the United States to raise tariff walls to protect domestic industry.
China may appear to have a competitive advantage in everything but by definition it cannot have a comparative advantage in everything. Every country has a comparative advantage because countries have limited resources and no matter how efficient their production overall, they still face trade-offs that determine what they can do better. Global demand for green goods will almost certainly exceed what China alone can supply.
Not even China can afford to subsidise production of goods for export that it does not have a comparative advantage in. If it tries, history shows us that growth will atrophy as support for sectors that are a drag on the economy stifles new sources of growth. Growth in China has slowed and it now faces demographic headwinds with an ageing and shrinking population. It might well become old before it becomes rich, unlike Japan.
Capital is leaving China, including foreign and Chinese direct investment looking for production elsewhere due to higher production costs in China, avoiding US tariffs and diversification generally driven by the search for supply chain resilience, and the normal drivers of foreign investment.
Japan's sources of comparative advantage will continue to be dominated by what China cannot easily or quickly attain: high environmental, social and governance (ESG) standards, high quality and trust. These elements in international competitiveness are what are becoming more important and what the rest of the world, including China’s middle class, demands. The rule of law in Japan, high quality standards, education and social capital, as well as soft power are Japan’s advantages and define its continuing complementarity to the Chinese economy.
Even if the US and European economies retreat from Chinese competition, Japan should not. Retreating from competition in the name of economic resilience or economic security will mean Japanese firms will not be globally competitive.
Japanese firms are adaptive and thrive in the global economy. The focus for Japanese economic policy needs to be on maintaining openness at home, sharing the gains from trade across society and proactive economic diplomacy to keep the global economy open.
The “China Shock” argument— surges of cheap Chinese imports into the United States after China entered the WTO wiped out jobs and created the US rust belt—fails to recognise that much of the rest of the world which also experienced surges of Chinese imports did not suffer in the same way. They absorbed the gains from trade with China equitably; the United States failed to. The causes of US protectionism are structural, driven by stagnant living standards for many Americans, a maldistribution of the gains from progress—both trade and technological advances—across society, and the lack of an adequate social safety net, including universal healthcare, access to education and the domestic policy action needed to correct it. The continuity of Trump’s first term protectionist policies by President Joe Biden confirms Trump to be more of a symptom than the only cause of the problems that America faces.
Countries in Southeast Asia that compete more closely with Chinese products, as well as other manufacturers, like Japan and South Korea, managed the adjustment costs of the rise of Chinese manufacturing better, and shared the gains across society because of their better social protection systems. Trade and investment grew, including trade in the same industries, through intra-industry trade with China.
Proximity and scale are the biggest drivers of international trade. Japan and Southeast Asia have benefitted from China’s rise and they can continue to do so, deepening their interdependence.
Mark Carney is wrong on one key point: the rules-based trading system is not dead. It remains absolutely crucial to Japan’s economic security. It still keeps markets open for Japan’s exports and allows Japan to source strategic raw materials, food, cheap manufactured goods and critical minerals from international markets where they are produced most cheaply.
Where Carney was right was that countries need to work together to find their way in a world drifting away from accepted rules towards ‘might is right’. Japan is perhaps the most important country that can lead that effort.
Just as former Prime Minister Shinzo Abe saved the CPTPP after President Donald Trump blew it up on his first day in office in 2017, Prime Minister Sanae Takaichi can help lead a coalition of countries to protect the multilateral trading system. It should not be a coalition against the United States or China but one that keeps the system functioning for eventual US re-entry and that recognises how locked in China is to that system despite its aberrations.
It is self-defeating for Japan to forego opportunities to shape the emergent regional and international order out of fear of being seen by Washington as too close to China. Instead, Japan should coordinate its diplomatic and economic leverage to open space for dialogue and cooperation with Beijing on matters of shared importance — from climate to trade.
China has a substantial stake in the established system of trade rules and has a demonstrated preference for enforceable rules including through its membership of the Multi-Party Interim Appeal Arbitration Arrangement (MPIA), the dispute settlement system work-around for the WTO that worked to Japan’s advantage.
When Japan was a rising power, being cut out of international markets was a cause of energy, economic and political insecurity. That should inform Japan’s priorities in protecting the system that preserves openness for other rising powers, including China and India. A loss of confidence in the system by China would help unravel its trade with the rest of the world, destroying trade’s pacifying powers.
In the zero-sum world of weaponised economics and economic security, Japan has chokepoints in supply chains against China in semiconductor equipment and materials. But China has more. These chokepoints, or leverage from market concentration are only temporary and abusing them is the quickest way to lose leverage as firms and governments rapidly adapt to find alternatives. Those alternatives are numerous in an open global economy. China in fact faces many chokepoints against it given it is the world’s largest trading nation.
The reality is that a Chinese economy and society that is less integrated into the global economy would be one that carries with it more international political risks, not less. Interdependence acts as a constraint on China that does not eliminate the prospect of war but makes war much more difficult and costly. That constraint is much stronger for an economy like that of China compared with one like Russia that is not deeply integrated into regional or global trade and production networks.
Japan can create pathways to manage trade with China and to steadily build trust through diplomacy and deepened trade.
The promise of CPTPP entry is another powerful incentive for reform in China. Realism and pragmatism would suggest a process that allows China to demonstrate progress towards reform and that tests trust in its credentials on a path towards membership has the potential to transform Chinese state-owned enterprises and lock in further market reforms. If China fails to reform or meet the standards of the agreement, it should not be admitted to an accession process. But a genuine process needs to start with the understanding it will be admitted if it does.
The price for China’s entry into CPTPP could be a treaty-level commitment to maintain the security of supply of critical minerals for which it currently dominates global supply. For those in MPIA and CPTPP, there can be a mutual disarmament of economic weaponry.
It’s through these regional arrangements and initiatives that Japan can best address global problems. Making progress on a subsidy code—agreeing to what subsidies are reasonable versus what are simply protectionist—and codifying what security exceptions are legitimate, for example, in Asia with ASEAN, China and Australia, could be easier to achieve regionally than it would be in the WTO and more effective than in groups of advanced industrialised economies. Getting a clear framework that draws the line between necessary economic security and protectionism is also key. Those efforts can be a first step in plurilateral arrangements that connect to Europe, Canada and other willing partners to protect the rules-based order.
