Since the late 1980s, Chinese diplomatic rebukes and popular protests over issues relating to the legacy of World War II have become increasingly strident. During Prime Minister Koizumi’s era the Chinese government protested against his visits to the Yasukuni Shrine, and opposed Japan’s bid for UN Security Council membership.

In more recent years the main source of tension has been territorial disputes over the Senkaku/Diaoyu islands. In 2010 the Japanese coast guard arrested the captain of a Chinese fishing boat that had allegedly rammed two Japanese coast guard vessels in contested waters. The arrest prompted government protests in China. The Chinese government called off political talks with Japan and temporarily suspended a series of bilateral student exchanges. The response in Japan was chilly. A Yomiuri Shimbun survey published in October 2010 reported that 89 per cent of Japanese believed that the Chinese government ‘went too far’ on the Senkaku/Diaoyu issue. Worse, the survey found that only 13 per cent of Japanese respondents felt any trust in China.

Routine political and territorial rifts make it easy to conclude that the Japan–China relationship is dominated by intractable animosity. But the economic connection that has long brought these two states together should not be overlooked. China is Japan’s largest trade partner, and Japan is China’s second-largest trade partner after the US. More importantly, Japan is one of China’s major sources of foreign capital. Over the past decade Japanese foreign direct investment in China has grown tenfold as Japanese firms have shifted their manufacturing operations to China. Both large firms and small- and medium-sized enterprises are part of this trend.

Sino–Japanese economic interdependence is set to deepen following the Chinese government’s decision in May 2012 to allow direct convertibility between the yen and the renminbi. This makes the yen the first currency other than the US dollar to establish direct convertibility with the renminbi. As China’s second most important economic partner, Japan was a natural first choice for Beijing, whose efforts to internationalise the renminbi and reduce its reliance on the US dollar have received much publicity in recent months.

Sino–Japanese ‘hot economics, cold politics’ make this relationship a poster child for the liberal thesis that economic interdependence is a source of peace.

This may seem counterintuitive. After all, the strength of economic ties has not actively improved other aspects of the relationship. However, strong economic interdependence has helped to raise the costs of conflict. Since the end of World War II economic ties have prevented sour political relations from turning into outright conflict. Even during the most difficult years of the Cold War, when the US put pressure on Japan not to trade with ‘Red China’, Japanese and Chinese business leaders, politicians and government officials worked hard to negotiate a set of small, unofficial trade agreements. Even during the worst years of the Cold War era, the two sides relied on economics to build a relationship where politics and diplomacy could not.

Yet the ‘hot economics, cold politics’ that have worked so well in sustaining the bilateral relationship for over six decades is based on US primacy in East Asia. This East Asian regional order has allowed Japan to pursue economic engagement with China while being backed up by the security guarantees of a hegemonic US. The rise of China may change all this. Will the paradoxical quality of Sino–Japanese relations be sustained at a time of shifting power relations in East Asia, or is this a new phase in Japan–China relations?

There are some worrying signs that the basis of the Japan–China relationship is changing. Both the 2011 and 2012 Defence of Japan: Annual White Paper raised detailed concerns about China’s growing military budget, lack of military transparency and the intensification of China’s military activity in the East and South China Seas. There is also strong and growing concern among the Japanese public over China’s military rise. Polling by Pew Research in 2011 found that 87 per cent of Japanese view China’s growing military strength as a ‘bad thing’ for Japan.

Linked to this, more and more Japanese are finding comfort in the US alliance. The Democratic Party of Japan came to power with plans to reach out to China and take a more independent stance toward the US. But support for this approach was lost when the Japanese public grew concerned that the Hatoyama government was taking a cavalier attitude towards the US–Japan alliance. In the last two or three years China’s behaviour has become increasingly provocative, and this has helped to push Japan closer to the US. A 2011 joint statement by the US and Japan explicitly referred to China’s lack of military transparency as an area of mutual concern, and Tokyo and Washington have strengthened their cooperation in areas such as intelligence, missile defence, space security and cyber security.

Even more worrying is the development of the Trans-Pacific Partnership (TPP), a new US-led exclusive economic grouping in the Asia Pacific. Although the TPP is still being developed, the strict standards on intellectual property rights, labour, the environment and the regulation of state-owned enterprises the US is pushing for will make it extremely difficult for China (and other transitional economies) to qualify for membership. Any perception that China is being deliberately locked out of a key regional economic grouping creates a risk that economics will be used to enhance rather than constrain political and strategic tensions between China and its neighbours. So far official statements suggest that Beijing has adopted a wait-and-see attitude toward the TPP, although in late 2011 a Chinese Foreign Ministry official stated that ‘we hope all [trade] mechanisms could remain transparent and inclusive’. China’s official Xinhua news was more blunt: ‘The TPP, which pointedly excludes China, is widely seen as a thinly disguised counterweight to free trade blocs in the region’.

Yet there are positive signs that ‘hot economics’ will continue to temper the ‘cold politics’ of the Japan–China relationship. The Japanese government is dragging its feet on the TPP, and it is unlikely that the prime minister, Yoshihiko Noda, will be successful in taking on the Japanese agricultural lobby and so enable Japan to join the new economic grouping. At the same time, Japan has strengthened its free trade negotiations with China and South Korea, and the three countries recently concluded an agreement that will deepen trilateral investment. There are also clear signs that despite growing concerns about China’s military rise, the Japanese public continues to support increased and open economic ties with China. In December 2010 an Asahi Shimbun survey found that 64 per cent of Japanese believed that the most important issue in the US–Japan–China relationship was not strengthening the US–Japan alliance against China, but finding ways to deepen the mutually beneficial economic ties between the three countries.

Japan and China have long used economics to sustain an otherwise difficult relationship. There are a number of reasons to expect that they will continue to do so for many years to come.

Amy King is a doctoral candidate in International Relations at St Antony’s College, Oxford University. Her research is supported by an Australian Rhodes Scholarship.

This article appeared in the most recent edition of the East Asia Forum Quarterly, ‘Japan: leading from behind’.