China and Japan: A growing trade surplus

Derek Moorehouse - Fri 14 May, 2004

...Alone amongst major manufacturing nations, China has a large and growing trade surplus with Japan...

China and Japan: A growing trade surplus

Japan feels threatened by China’s staggering rate of growth - or so Beijing and Tokyo would have you believe.

On the surface, the Japanese have long worried about ‘kudoka’ - the hollowing out of their manufacturing sector under pressure from China. China’s cheap manufacturing costs have also been blamed for the deflation which Japan has suffered for the last ten years.

There is a logical inconsistency here. Chinese growth and Chinese slowdown cannot both be bad for Japan. Goldman Sachs’ recent “BRICS Report” forecast that China could become the world’s largest economy by 2041. Japan can only benefit from having its massive Asian neighbour grow so rapidly.

The cost to the US and Europe, on the otherhand, is hard to imagine.

Japan has been spending big money to secure itself the status of China’s No.1 trading partner. Yet their ‘entente’ has gone virtually unnoticed in the Western financial media until now. As Eamonn Fingleton notes in the latest issue of Prospect, Japanese aid to China between 1979 and 1999 totalled $24 billion - around two-thirds of China’s total foreign aid for the period. Around 60% of that aid went to developing China’s transport infrastructure. By contrast, the US has given no significant aid to China since the war.

The Japanese are pouring yen straight into China through other sectors, too. Tourism more than quadrupled between 1987 and 2000. Last year, Japanese direct investment grew 20% year-on-year to more than $5 billion, the highest figure ever. This investment is being rewarded. Japan delivered almost 30% of all foreign technology supplied to China last year - more than any other trading partner.

Indeed, Japan's trade with China in 2003 totalled a record $132.4 billion, a fifth consecutive annual record. China provided nearly 80% of Japan’s export growth last year, according to David Pilling in the Financial Times. Mamoru Yamazaki, chief economist at Barclays Capital in Tokyo, estimates that China accounted for more than a third of Japan's real GDP growth, too. Alone amongst major manufacturing nations, China has a large and growing trade surplus with Japan.

Japan's trade with the United States meanwhile is shrinking. Japan’s imports from the US fell some 23% in the five years to 2002. Imports from China rose by nearly 50% over the same period.

In 2003, US imports to Japan increased by just 1.7%, and Japanese exports to the US fell a further 2.6%. Last year finally saw ‘Greater China’ - including Taiwan and Hong Kong - overtake the US for the first time as Japan’s largest export market.

The truth is, China and Japan’s economies are complementary rather than in direct competition with each other. China has clear advantages in labour-intensive industries, while Japan has the lead in technology. Its exports to China are led by general machinery, electric equipment and transport equipment - the areas in which Japan is posting the largest export gains. High-tech Japanese sectors such as semiconductors, semi-finished audio-visual equipment, telecommunications, and visual equipment - as well as industrial machinery, automobiles and auto parts - are booming thanks to rocketing Chinese demand.

Estimates from the Research Institute of Economy, Trade and Industry (RIETI) in Japan show that China and Japan compete for only about 20% of their exports to the US in value terms. Make allowance for the fact that Chinese exports have a higher imported material content, and that figure reduces further. And even this restricted competition tends to be limited to low-value added industries, where Japan enjoys no comparative advantage.

Hence Japanese companies have been able to benefit by switching production to China to benefit from lower production costs, and from the development of new domestic markets. Companies like construction-equipment maker Komatsu have been able to post strong increases in profit thanks to fast-growing sales in China.

Take note - Japan's trading relationship with China is still at an early stage. To gauge how early, consider that in 2002, China's per head GDP was less than one-thirtieth of that of Japan’s.

In 2004, the Economist Intelligence Unit predicts, Japan will record a second year of above-trend growth of around 3%. But exports to China will continue to increase...and the stimulus from China is hardly likely to disappear - even assuming interest rate rises from the People’s Bank of China.

China’s GDP is forecast to slow from above 9% in 2003 to 8.7% in 2004 and 8% in 2005. Still pretty remarkable, and much healthier than the lumbering US or ailing Eurozone - a fact which Tokyo is only too aware of. This leads us to the other side to the Sino-Japanese relationship: oriental politicking.

Ever since Japanese Prime Minister Ohira visited China to agree new co-operation deals in 1979, both countries have sought to downplay their friendship...for fear of upsetting Washington. Japan has enjoyed unique support from the US since its post-war occupation began in 1945. China has openly courted America’s blessing on UN and WTO membership, beginning with Nixon’s historic visit to Beijing in 1972. Neither wants the world’s current No.1 superpower to notice their growing economic and political ties will undo her current dominance.

Perhaps the most underhand trick used to confuse the US has centred on the infamous Yasukuni war shrine in Tokyo. “The Chinese press is regularly outraged by Japanese politicians visiting the Yasukuni shrine,” writes Eamonn Fingleton, “notorious for commemorating war criminals who visited terrible atrocities on millions of Chinese citizens in the 1930s and 1940s. The visits first became a flashpoint in April 1979.

Just a few weeks previously, Deng Xiaoping had paid a historic visit to Tokyo. Fingleton: “He had been warmly received - so much so, that it was felt on both sides that some contrivance was needed to hide the true closeness of Sino-Japanese relations...[and] in a leak to the press, the previously unexceptionable Yasukuni shrine was said to commemorate 14 top Japanese war criminals. Prime Minister Ohira then announced that he planned to visit the shrine regardless.”

Another example of Sino-Japanese collusion would seem to be the incident last September when a party of Japanese tourists held a three-day orgy with some 500 Chinese prostitutes...on the anniversary of Japan’s attack on Manchuria in 1931. Amid the Chinese press’s outrage, however, the Japanese corporation which had paid for its employees to visit China was never named. Fingleton: “Even in denunciations in China’s internet chat rooms, the company’s identity was carefully withheld.”

And while Tokyo and Beijing work to keep the extent of their friendship hidden from Washington, the growth of their economic trade is accelerating. In 2003, exports to China from Japan shot up a record 44% to $60 billion. Paul Sheard, a Tokyo-based economist for Lehman Brothers, says: "The panicky rhetoric about China you used to hear has completely gone off the radar screen."

The only panic over Sino-Japanese relations now will be in Washington.


Regards,
Derek Moorhouse
for the Daily Reckoning

P.S. China’s excellent growth prospects do not make it a good place to invest. Almost all the companies that are publicly traded are controlled by the government. The country’s stock exchanges are more like state-run casinos than places of rational investment. Standards of corporate governance are much higher in Japan - which was identified by John Templeton as the first-ever ‘emerging market’ in the 1950s and has a much longer history of receiving foreign investment.

Japan’s secret deals with Beijing offers you an excellent opportunity if you want to buy into China’s future growth. But at the end of April, the Nikkei 225 traded at twice book value, and on a forward price-earnings ratio of just under 27. Those ratios aren’t cheap...and they follow an excellent 12-month run. The prospect of a temporary Chinese slowdown, however, could create buying opportunities for aggressive UK investors like you - and soon.

The easiest way to profit from Japan’s trade with China is to buy an investment trust than holds a broad selection of Japanese stocks. Unlike unit trusts, the price of an investment trust moves independently of its underlying asset value - so if you time it right, it may be possible to buy a basket of Japanese blue chips at a discount to their true worth.

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