Improving Japan-China relations and the global trading system

Author: Shiro Armstrong, ANU

The Democratic Party of Japan’s (DPJ) secretary general and power broker Ozawa Ichiro recently took 645 DPJ members and other leaders to China in an unprecedented move for both countries. This is a big step in following up on the DJP’s promise to mend relations with China. There is talk now of making progress on the difficult history issue and of moving beyond it. Other rumours have Prime Minister Hatoyama visiting Nanjing this year — the site of Japanese imperial war atrocities — in exchange for a visit by President Hu to Hiroshima.

The Sino-Japanese relationship has come a long way since a decade ago. Between 2001 and 2006 tensions rose, there were no leadership visits between the two countries and relations reached a low point in 2005, with anti-Japan protests and isolated boycotts of Japanese products throughout China.

Much has happened and changed in the Sino-Japan relationship in recent times. As the political relationship has fluctuated since normalisation in 1972, the latest upswing over the last five years could be the start of a longer term positive trend. Yet the ups and downs in the China-Japan political relationship over the past three decades never really derailed the growth of their economic relationship, despite the fears that it would. It is worth asking why that was so. History is littered with examples of bilateral relationships that have had large disruptions to trade and investment because of bad politics resulting in costs to both sides. That hasn’t been so with China-Japan in recent times.

Some of it is the standard liberal argument heard in strategic studies of increased mutually beneficial trade promoting peace. But there are costs involved in bad relations, even in the Japan-China case. There is increased business risk from fluctuating political relations with uncertainty about future relations. In the extreme case of military conflict or trade embargo these costs are clear. But even with moderate, low intensity conflict, the inability to sign or update agreements or to mediate and deal with problems can hurt commerce. This is one reason so much emphasis was placed on the importance of Japan-China leadership visits. The only bilateral trade agreement between Japan and China is the Long Term Trade Agreement (LTTA) which was signed in 1978, and the bilateral investment treaty (BIT) is from 1988 – both out of date and irrelevant to the nature of trade and other business between China and Japan today. The two countries have the third largest trading relationship in the world and one of the most important.

Political tensions rose significantly in 2001, triggered by Koizumi’s visit to Yasukuni Shrine and coinciding with the year that China became a member of the WTO. Joining the WTO saw a huge and immediate boost in Chinese trade although most Chinese tariff reductions were delivered prior to accession. The institutional effect of China’s accession to the WTO — the confidence that it gave in doing business with China — boosted trade remarkably, despite what Andrew Rose says about the incapacity of the WTO to lift trade between members.

It was China’s commitment to the global trading system from the 1980s, evidenced by their large scale unilateral liberalisations on the way towards accession that gave Japanese investors and traders confidence in doing business with China. China’s 15 year accession process into the WTO was the longest thus far.

China’s pro-reform leaders used the international institution of the WTO to increase the pace of, and lock in, reforms. The reforms were wide-ranging and importantly secured financial, legal and economic institution changes. No other member joining the WTO has made so many commitments on the way to accession. These included transparency issues related to legal and administrative policies and the resolution of domestic commercial and trade disputes by foreign firms that also affect domestic firms.

China’s lead negotiator for WTO accession, Long Yongtu, has said:

We must let those [WTO] rules that stand at the core of the market economy, and which have to be obeyed, take firm roots in our society and country, so that our own market economy may become one that is truly orderly, efficient, honest and clean.

Long understood that simply reducing import barriers, both tariffs and non-tariff barriers, was insufficient for China to benefit from globalisation and join international production networks. Japanese firms, for example, wanted market mechanisms entrenched in China and saw the WTO as playing a key role in this.

Accession affected China’s economic interaction with the international economic community, including Japan. It meant the global economic community recognised China as an equal partner and one that had committed to progress towards economic globalisation. More fundamentally, it signalled China’s commitment to a rules-based global trading system, illustrated by its willingness to place constraints on Chinese policy makers towards foreign traders who were party to the same commitments. China’s membership in the WTO also affected the behaviour of China’s major trading partners, including Japan, towards China. It changed Chinese policy behaviour and the environment in which foreign and domestic firms operate, and the behaviour of foreign and domestic firms operating in China.

The process of WTO accession provided the international community and China with a rare opportunity to set out principles governing trade relations between China and the rest of the world. Furthermore the policy credibility and predictability that arose from accession protocols limited the likelihood of discretionary interventions in trade and in respect of FDI in China. It accorded to China’s trading partners the same treatment to which they are also bound by the rules that govern the world trading system when dealing with China.

Japan, of course, has been committed to the multilateral system and much of its economic development in the post war period was underpinned by its integration into the global economy.

The Japan-China economic relationship is driven by complementarity in economic structures and the multilateral settings in which both are deeply integrated. These factors have been more powerful drivers of trade than the ups and downs of politics.

What emerges from consideration of the China-Japan economic relationship is the power of strong multilateral institutions like the WTO in overwhelming the vagaries of political disturbance to commerce. At the same time it highlights the risks that damage to those institutions might inflict on stability in not only the international economic but also political system. These risks are prominent as the advanced economies take longer than the large developing countries to recover from the global recession, with a real threat from the re-emergence of protectionism.

The G20 has done much to push back against protectionism but the course of the Great Depression reminds us that protectionist pressure will intensify in the advanced economies as recovery lags the rest of the world. If the global trading system that underpins trade and much investment begins to falter, and trade or investment protectionism breaks out between Japan and China, there is still the risk that the economics which has dominated the politics in the last thirty years, could give way to more difficulties in the politics.