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No.3 ,Politics  Oct 01, 2010

HOW SHOULD JAPAN DEAL WITH A RICH, STRONG CHINA?

The economic development that China has achieved over the past 30 years is a historic phenomenon. The key event that set it off was the reform and open-door policy that Deng Xiaoping, an extraordinary leader, launched in 1979. With this revolutionary move Deng stripped the Communist Party of China of its erstwhile moral mission. He conceived the brilliant strategy of opening the gates to the material desires of the masses while preserving the hold of the state over the political system. Over the subsequent three decades this approach achieved great results.

We can cite a number of factors that helped make this possible. First, Deng’s capable successors continued his policy line. Second, the economy started from a low level, and so it was possible for it to grow at a rapid pace over an extended period–and to do so without running into constraints on its development. There were initially no problems in areas like energy, resources, and environmental destruction; this made it possible for development to take place in what one might call an open space. Third was the strategic wisdom of the decision to focus on manufacturing a full range of consumer goods by actively introducing foreign capital and technology and linking these up with the country’s virtually limitless supply of cheap labor. A fourth factor was timing: Japan had led the way in development within Asia, followed by the so-called four Asian dragons (South Korea, Taiwan, Hong Kong, and Singapore) and the three tigers of Southeast Asia (Thailand, Malaysia, and Indonesia); as of the 1980s East Asia as a whole was riding an ascending current, and the time was ripe for China to emerge. Furthermore, after the Berlin Wall came down in 1989, marking the end of the Cold War, the wave of globalization swept across the world economy, resulting in growth in demand; this perfectly matched the rise in China’s capacity to produce consumer goods. This combination of favorable factors made it possible for Deng’s revolutionary policy to produce tremendous results over the following 30 years.

In a longer-term historical context, China has a 4,000-year history, over the course of which it has experienced the rise and fall of many dynasties. Much like people, dynasties have life stages, passing from youth to maturity, stagnation, and decline. Each such cycle of rise and decline has generally taken 300-350 years or so. Today’s China does not have an emperor, but it is definitely under a dynasty of sorts. The current dynasty may be said to have started not in 1949, when the Communists officially took power, but around 1840, at the time of the First Opium War. That means it is entering its prime right now. I believe this sort of historical perspective is of reference when considering the prospects for China’s rise in the years ahead.

Can the Rapid Growth Be Sustained?

There is much debate in Japan about the prospects for the Chinese economy, but it seems likely that it will be able to keep growing at a pace in the range from 5% to close to 10% for at least another 10 to 20 years.

The first reason for this assessment is that there is still tremendous demand for investment in infrastructure, along with latent demand from the household sector for consumption. Second is the country’s rural-urban population distribution. Looking at the historical record of countries around the world, we find that when countries’ economies start to develop, their population is split between the country and the cities at a ratio of 75 to 25. This gradually shifts to a 50:50 ratio, and eventually, as the country joins the ranks of the advanced economies, it turns into a 75:25 ratio weighted toward the cities. China’s rural-urban population breakdown is now precisely at the 50:50 point; the country has entered the second stage of the shift toward an urban-majority population, and the movement of people into the cities will continue for some time yet. Another 25% of the country’s population, or some 300 million people, can be expected to swell the ranks of the city dwellers, meaning that the urban labor force will continue to grow as well. Countries enjoy what has been called a “population bonus” when they have swelling ranks of young people entering the labor force and increasing their productive power. Then, after this growth stops, the labor force plateaus, and the population of seniors starts to rise. That is what is happening in Japan now. In China, meanwhile, because of the one-child policy, the working-age population will soon start to decline, but at least for the past 30 years the country has been collecting a population bonus, and it is still continuing to do so.

A third reason to expect China’s growth to continue is that it still has a high savings rate. This is due in part to the inadequacy of the social security system and the high costs of education and medical care, which feed concerns about future expenses. Be that as it may, a high level of saving means that there is plenty of money available for investment. And as a result, public finances are still in good health. The fiscal deficit is just a few percent of gross domestic product, and rapid economic growth is causing tax revenues to rise; for this reason as well, the government is in a position to spend more without additional borrowing.

Fourth, though lively economic growth has led to what people have identified as a bubble in the real estate market, and banks may face problems in their balance sheets as loans turn sour, the government has the financial leeway to help them out with its tax revenues. Ultimately the only way to make a clean sweep of banks’ bad assets is through infusions of public funds, as we saw in Japan in the late 1990s. China’s government is in a position to provide this sort of funding, so the problem of nonperforming assets will probably not be very serious.

Fifth, though the danger of speculative bubbles certainly exists, up to now the Chinese authorities have taken a careful and meticulous approach, implementing relatively gentle treatment when the economy seems to be overheating a bit rather than overreacting with drastic measures. Thanks to their repeated application of measures like administrative guidance directing banks to restrain their lending and increases of half a percentage point in the deposit reserve ratio, they have been able to control the situation quite well, avoiding excessive cooling from the sudden collapse of bubbles.

So it seems safe to conclude that the current rapid expansion has enough momentum to carry it forward for at least another 10 years. With a growth rate of 7% a year, an economy doubles in size over a 10-year period. At that rate, China’s GDP, currently roughly equal to Japan’s at $5 trillion, will grow to $20 trillion in 20 years. The GDP of the United States is now about $15 trillion, and even though it may expand in the years to come, after another 20 years China’s economy may be comparable to the US economy in scale.

In terms of per capita GDP, China’s current level of $4,000-$5,000 is only about one-tenth of Japan’s $40,000. But it seems virtually certain that this figure will double and reach the $10,000 mark within the next 10 years. Per capita GDP of $10,000 is a typical figure for a newly industrializing country.

So it seems that China’s economic prospects for the near term are good. How about the longer term, though? Here we find some knotty problems. The first is demographic. China’s population is steadily aging. In another 15 years the working-age population will plateau, and this will cause the growth rate to fall. The burden of social security expenses will grow, and productivity will stagnate; these developments will inevitably make it impossible to keep up rapid economic expansion. This day is sure to come.

The second long-term problem is also serious: Growth will increasingly run into limiting factors. The costs of items including food, water, energy, resources, and environmental conservation will rise sharply. For an economy as huge as China’s–one that is now on the same scale as Japan’s and that will eventually match America’s–the conditions required to achieve 10% growth will become truly daunting. The Chinese authorities realize this, and they are now working valiantly on the environment and new energy sources and at securing a supply of resources. This has been giving rise to a different set of problems.

The third problem is related to the second, namely, the fact that China will come into competition with other large countries within Asia. India is comparable in size, and it is racing after China. The region also includes various other big countries, such as Indonesia and Vietnam. It will surely be impossible for them all to achieve rapid growth at the same time.

So, over the medium to long term, China faces some major risks that could affect its economic prospects. Though growth may continue at a 10% rate for two or three years, it will probably be impossible to avoid a gradual decline to 5%.

Cooperation and Rivalry

How are economic relations between Japan and China likely to develop in this context? What should Japan do on the basis of its own position?

Naturally the two countries will have some fields in which their relationship is cooperative and others in which they are competing. The first area in which they can and should cooperate is trade. Japan and China need to expand their mutual trade ties in a complementary manner. The Chinese will probably want to buy deluxe items and high-quality goods in certain niche areas. In practice we see demand for Japanese-made precision machinery, for example, and agricultural products like high-grade grapes, and demand for painstakingly produced goods like these will continue to grow. Going in the other direction, the Japanese have demand for goods of a certain quality that can be produced less expensively in China than in their own country.

A second area for cooperation is the two countries’ complementary investment relationship. Chinese investment in Japan has already begun and can be expected to grow. The biggest objective is the acquisition of technology. Meanwhile, as we see in the case of the automobile industry, Japanese companies are stepping up their investment in China with the aim of tapping that country’s huge market.

Third is the area of general exchanges. Both countries will benefit from stepped-up exchanges not just in economic fields but in a variety of other areas as well, such as culture, academic research, overseas study, and tourism.

Fourth, the two countries can work together in dealing with others. For example, they could naturally undertake joint development of resources and energy, with both countries providing funds and technology. The level of Chinese technology has risen considerably, and it would be possible for Japan and China to participate jointly in projects to develop infrastructure, such as railways and roads, in developing countries. Such cooperative endeavors have already begun on a private-sector level. The potential for bilateral cooperation in this field is extremely great.

At the same time, however, there are bound to be areas of competition. The prime example is the drive to secure resources. The Senkaku Islands and their environs are obviously an object of such rivalry, and in the period ahead we will see the two countries competing all over the place for supplies of energy and resources. This is an area that requires Japan’s serious attention, and China is not the sole rival. The power to secure resources involves not just money but also diplomatic and military strength; without such power a country will be at a disadvantage in the global competition to win adequate supplies. This is an area where there is room for some bilateral cooperation, but we must also be prepared for an increasing number of cases in which the two countries are rivals.

Second, we are bound to see competition between Japan and China in third-country markets. For example, the Chinese have started exporting automobiles to the US market. The rivalry may intensify in the period ahead.

Third, the two countries will be competing for leadership positions in international economic institutions, such as the International Monetary Fund, World Bank, and Asian Development Bank. This rivalry is already underway, and it is bound to continue.

Finally, an area of particular concern to Japan is currency. People often ask me how the relationship between the Japanese yen and the Chinese yuan (renminbi) will develop. The idea seems to be that the yen is now the strongest and most important currency in Asia but that as China’s economy grows and develops, the yuan will take its place. This view is not completely wrong, but we need to look at this issue from a broader perspective.

At present the sole key currency in Asia is the US dollar; unfortunately the region has nothing like the euro. So the dollar accounts for the lion’s share–almost 70%–of international transactions among Asian countries. The euro and the yen play only secondary, supplementary roles in the region. And the yuan has yet to become an international currency, because the Chinese government restricts it from being used outside the country. In that sense the yuan is basically not even in the picture yet; one might say it has just begun to peep over the horizon. Even if the dollar weakens, no other currency is in a position to take its place, so we are unlikely to see a substantial change in the situation anytime soon.

If the Chinese economy continues to develop steadily for the next 20-30 years, China can be expected to relax the current restraints and allow the yuan to be used more freely for international trade and investment transactions. The Chinese authorities have already started allowing it to be used in neighboring areas. If this process continues for the next two or three decades, with the use of the yuan gradually spreading, starting with the border districts of Vietnam and Myanmar and places like Hong Kong and North Korea, in time the dollar will come to be used less and the yuan more. As for what will become of the yen, that will depend on Japan.

China wishes to turn the yuan into a key Asian currency at some point, but this still lies far in the future. An important issue in this connection will be stabilization of the exchange rates among the dollar, yen, and yuan. Another point is the need for major markets in that currency. In order for a currency to circulate widely on an international level, it is essential that there be extremely large, free markets for investment and fund raising in this currency using a variety of financial instruments at any time. At present such markets do not exist for the yuan. That is why the Chinese authorities are now assiduously promoting the development of Shanghai as the central market for the yuan. They hope that when the yuan comes into international use, Shanghai will be the central financial market for Asia, becoming an international financial center comparable to New York and London. This ambition is sure to lead to rivalry between Tokyo and Shanghai. Actually it will be a four-way race, also involving the already-developed markets of Hong Kong and Singapore.

Power Shift

Nowadays I often hear Western policymakers and business leaders using the term power shift. They are expressing the view that the center of the global economy is shifting from the West to the East–in other words, to Asia–and, more concretely, they are voicing a sense of crisis at the perceived shift of the world’s power center from the United States to China. Some people even describe this historic power shift as the greatest transformation since the Industrial Revolution. This will probably be the biggest issue not just for the global economy but in every field over the next several years.

How do the Chinese feel about other people predicting that China will become the center of the world? They doubtless hope to “recover” their country’s status as the center at some point. Until the seventeenth century, China was in fact the world’s greatest empire. After Deng Xiaoping’s revolutionary policy shift, one often heard Chinese people saying that the first 30 years would be devoted to the economy and the 30 years after that to politics. This may be interpreted as a great 60-year plan: 30 years to raise the economy to a global level and another 30 years to restore China to the central position in world politics. China is now focusing on three major objectives: (1) enriching the country and strengthening the military, (2) maintaining domestic political and social stability, and (3) maintaining world peace. It has no intention of challenging the United States or seeking external hegemony. Another point that the Chinese constantly note is that China is still a developing country. The Chinese have clearly expressed their national strategy in this manner.

Some elements of this strategy have been changing, however, particularly in the wake of the global financial crisis that struck in 2008. One factor is the evident weakening of the United States and other Western countries. The United States is struggling under the material and human burdens of its involvement in Afghanistan and elsewhere, and its global authority has become impaired. Meanwhile, the Greek crisis has further sapped Europe’s confidence. These developments have been accompanied by signs of change in the behavior of China, which had previously been keeping a low posture. On the economic front, America’s external liabilities have grown, and conversely China has become the world’s biggest creditor nation; this has been accompanied by a clear shift toward a bigger say for the Chinese and a weakening of the position of Western countries, especially the United States, in forums for international negotiations. Nowadays there is a sense that no progress can be achieved in the Group of 20, climate change talks, and other such forums without gauging China’s views. The recent negotiations between the United States and China concerning revaluation of the yuan also show a clear weakening of Washington’s position in bargaining with Beijing. In the 1980s, when the Americans were pushing for revaluation of the yen, they had bargaining chips with which to threaten the Japanese. But now, as they seek a stronger yuan, they have no such tools to use.

The Chinese have clearly started to feel greater confidence in their own power since last year or so, but that does not mean that they are rashly seeking to knock the United States down. China’s stance toward the United States might best be described as one of waiting for the ripe fruit to fall.

The biggest concern for Japan and the world as a whole is how to view the prospect of China actually replacing the United States as the leading global power. The key point to note in this connection is that a country must meet certain qualifications if it hopes to lead the world. It must be powerful not just economically but also militarily, diplomatically, technologically, and culturally. Unless it has a clear lead in these and other respects, it cannot aspire to be the global leader. Of particular importance in this connection is ideological power.

The countries that have been true global leaders over the course of history–the Roman Empire, Tang China, the British Empire, and the United States–have all had this sort of power. If we consider the prospects for modern China to become the world’s fifth such leading country, though it may be able to muster the necessary economic and military might, it is unclear whether it can wield ideological and diplomatic power. What sort of country is China, and what ideals would it pursue as the leader of the world? At this point we have no answers to these questions. Confucianism and Taoism are not so much ideologies as ways of dealing with society. And, as I noted at the beginning of this article, Deng Xiaoping did away with the moral mission of Communism, thereby taking away its ideological meaning.

We can feel a certain sense of security when dealing with the United States, even as we criticize and complain about it, because it has a clear ideology–a commitment to democracy, human rights, and freedom of thought and expression. The biggest barrier to China’s taking the United States’ place as the world’s leading country is its lack of ideological power. The people of the world are not satisfied with it in this respect.

How does this problem appear to the Americans, whose country stands to lose its hegemonic position? Recently they have become sharply more aware of the issue. Recently an official of a certain international institution shared this observation with me: The hegemon will change, but the principles that China follows as the leader will not be the same as those of the United States; that is what is so worrisome. Some Americans even declare that the transfer of hegemony is bound to be accompanied by a military conflict somewhere. Obviously people in the United States are taking the situation very seriously.

Being Good Neighbors

What sort of relationship should Japan seek to have with China as its neighbor? Needless to say, the two countries have ties that have continued for two millennia, one of the world’s longest bilateral records. And except for a few relatively short episodes, notably the attacks on Japan from Mongol-ruled China in the thirteenth century, the relationship was a good one until around the end of the nineteenth century. At that point, however, as the decline of the Qing dynasty became evident and as the Western powers ate away at China, Japan went on the offensive and emerged victorious from the Sino-Japanese War of 1894-95. This was a great victory for Japan, but it seriously damaged the bilateral relationship. The Japanese people forgot the friendly ties of the previous two millennia and started to look down on their Chinese neighbors. This attitude persisted, leading to the outbreak of the Manchurian Incident in 1931 and war between the two countries in 1937; the conflict became a quagmire, ending in Japan’s defeat.

Why did Japan go to war with China and then, from 1941 on, with the United States and its allies? The Japanese of the time misjudged the global situation and completely misread the extent of their own country’s power. In this sense we can say they committed a great mistake in terms of national strategy. Most regrettably, while posing as Asia’s leader, Japan turned the other nations of Asia into its enemies. This was a fatal blunder.

In 1945, when Japan paid for this blunder by going down to defeat, the Japanese made another mistake of great historical consequence: They failed to pin down where the responsibility lay for the mistake in national strategy. Immediately after the war the phrase ichioku sō zange (collective repentance by 100 million) was commonly heard, meaning that the entire Japanese nation should accept blame for the war. This was the worst fraud in Japanese history. Having everybody take responsibility means in effect having nobody take responsibility. The Japanese people lacked the power to pass judgment on the failure, and they were not in a position to judge. As a result, they are still unable to reply to criticism from China, Korea, and other countries. In the case of Sino-Japanese relations, this is the biggest reason for the two sides’ inability to mesh properly.

So how are we to look at China under these circumstances? We must recognize that China is the strongest country in Asia and that it will probably become even stronger and widen its lead over Japan in the years to come. This is the sort of country with which we must maintain friendly ties.

This does not mean, however, that we are happy to welcome China as Asia’s leader or the leading country of the world. We do not know today’s China well enough to accept it as a leader. This is in contrast with our existing relationship with the United States, whose leadership is based on an ideology that Japan completely shares–the spirit of democracy, protection of human rights, and freedom of thought and expression. In that sense, if we had to choose between the United States and China, at this point the United States would be our only possible choice.

Japan will need to develop its national power in a balanced manner in the future. No country in the world deliberately chooses to be weak. The elements that form the required balance include the economy, the military, diplomacy, technology, culture, and ideology, but it seems likely that Japan can contribute to the rest of the world particularly in the area of ideology. The experience of the recent economic crisis has probably added to the international value of some of the ideas that Japan has developed over the centuries–what we might call the Japanese brand of capitalism, which stresses trust between partners even more than the contracts that bind them, calls for the principle of competition to be tempered by modesty, and imposes restraint alongside the conduct of competition.

Japan should do its best to provide as much input as it can for China as a country that in a few decades will become Asia’s leading country and may even lead the world. Other Asian countries, such as South Korea, Thailand, Vietnam, the Philippines, and Indonesia, all share Japan’s misgivings about China. It would be quite reasonable for Japan to serve as spokesperson for all these countries. Having interacted with China as a neighbor for two millennia, Japan is in a position to play this role.

Translated from “Yutaka de tsuyoi Chūgoku to dō mukiau ka,” Sekai, September 2010, pp. 102-9, © 2010 by Gyohten Toyoo. Translated and published with permission of the author c/o Iwanami Shoten, Publishers.

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