The Effects of China’s Economic Slowdown on Japan

After three decades of economic growth, China’s economy is declining. Over the past three decades, China has experienced economic growth as its manufacturing sector has benefited from massive investment from both international and domestic investors. As a result of low manufacturing costs, large corporations such as Apple, Samsung, and Sony have moved their production plants to the region, making it one of the world’s leading production centers. However, recent Chinese figures indicate that the country is facing an economic recession, with factory production and retail sales declining in recent years. Acton (2017) suggests that the growth in China’s industrial output reduced from 7.6% in March to 6.5% in April 2017, falling short of the country’s expectations. Fixed investment data also shows a fall in investment growth from 9.4% in March to 8.3% in April. Furthermore, retail sales failed to reach forecasted levels, and industrial commodity prices declined. This slowdown in Chinese economic performance was primarily caused by decreasing demand.

The figure above shows that China’s economic growth has been declining over the past few years. In 1960s, the economies of India and USA were far stronger than that of China. However, Chinese economy rose by 19.63% in 1970, the highest economic growth rate in the recent history of the country. Apart from the poor performance in late 1980s and early 1990s, China’s economy has been enjoying two decades of strong economic growth. In fact, the People’s Republic of China reached a double digit of 14.3% in 2007 and remained stable through the 2008 financial crisis as U.S.A’s GDP went to a negative value between 2008 and 2010 (BBC, 2016). However, the economic growth has declined since 2010, falling below 7% for the first time in 2016 since early 1990s. This recent poor performance of Chinese economy may affect other economies in Asia and Australia. This report provides an analysis and evaluation of the impact that Chinese economic slowdown can have on Japan.

Trade and Investment Linkages between China and Japan

Japan is the second largest trading partner of China after the United States, with a total trade of $312.5 billion. Japan also sends thousands of tourists to China every year, and several Japanese companies have their investment bases in China. Despite the historical struggles for power and geopolitical rivalries in Asia, China and Japan have maintained strong trade relationships. The two countries have strong ties despite military tensions. The two countries exchange goods and services through exports and imports, and engage in tourism with each other. Despite the historical animosities since World War II, trade between the two countries reached a record high of $340 billion in 2014 (Drysdale, 2015). However, the trade volumes decreased to $312.5 billion in 2016; hence indicating a negative impact of the Chinese economic slowdown on bilateral trade relations between the two countries. China is now the leading trade partner of Japan, and Japan is the second largest trading partner of China. In 2014, Japanese investments in China reached $100 billion.

China’s major exports to Japan are mainly manufactured products, especially computers, broadcasting equipment and telephones; while China’s major exports to Japan are largely vehicles, ships and vehicle parts (Asian Development Bank, 2017). Japan is China’s third top export destination and third import partner. On the other hand, China is Japan’s second export destination and the leading import partner.

China also experienced an influx of foreign direct investments from Japan and the United States during its economic boom between 2000 and 2013 (Asian Development Bank, 2017). Japan’s foreign direct investments to China have been concentrated on manufacturing products, especially transport, machinery and electrical products. On the other hand, USA has invested in service industry more than the product market. However, Japan’s exports were more than American exports to China in the boom era. With the slowing economic performance of China, the foreign direct investments from both countries decreased significantly.

The successful Sino-Japanese trade relations have been affected by geopolitical rivalries between the two countries. Historically, geopolitics has been a big problem to international relations (Kwan, 2016). It is not a peculiar phenomenon to China and Japan; but it is a global trend in which countries try to exercise their powers to control their regions and the world. In this regard, geopolitical rivalries may have a significant impact on the economic interactions of China and Japan. In fact, the situation can be worsened by the current economic slowdown in China. Following the 2008 financial crisis, China exercised its powers to assert itself in the geopolitical domain (Drysdale, 2015). China used its strong economy as a geopolitical tool. If China continues to demonstrate its geopolitical powers through the economic slowdown, it may cause further diplomatic and economic problems with its trading partners.

The relationship between China and Japan has also been characterized with successful tourism activities between the two countries. According to Hongyong (2017), approximately 360,000 tourists from China visited Japan during the Spring Festival Holiday of February 2015. Tourism between the two countries enhances personal interactions among people from China and Japan, leading to improved diplomatic relations that may cause an integrated social and economic relations between the two countries. However, such economic relations may be affected by the dispute on the Island in the sea, East of China.

Impact of Chinese Economic Slowdown on Japan

The reduction of economic growth rates of China over the past few years has significant impacts on Japan and other trading partners. The impacts are both direct and indirect. Direct impacts include the effects of direct trade and investments between China and Japan; while indirect impacts include the effects felt through China’s trade with other countries of the world, which, in turn, affects Japan. For instance, Chinese trade with the United States may affect Japan’s economic performance through its trading relations with the U.S. China’s economic slowdown has affected many countries across the world, but its major trading partners are the most affected. Being an Asian economy, Japan is at a high risk of losing significant income following the decline of Chinese economic growth.

Foreign Direct Investments

The slow economic growth in China has led to decreased direct foreign investments. Chinese FDI fell by 0.2% following a drop in GDP growth by 1.2% in 2017 (Trading Economics, 2017). The figure below shows how the foreign direct investments of China have been impacted by the economic slowdown of the country.

Figure 2 above shows that the foreign direct investments of China decreased sharply in 2017, following the falling prospects of the Chinese economy. The outbound direct investments in China fell by 41.8% in the first eight months of the year. This poor performance in FDI indicates that its major trading partners are likely to be affected directly and indirectly by the economic slowdown.

The decreasing foreign investments from Japan to China have been caused partly by the geopolitical dispute between the two countries, and partly by the decreasing demand and poor economic performance of China. According to DW (2015), Japanese Foreign Direct Investments declined by 50% between 2013 and 2014. This data contradicts with Chinese foreign investments in other countries which rose by 16.8% in the same year. The political tensions and falling demand for consumer products in China has caused Japanese multinationals to refocus their investments to other ASEAN countries. The shift of Japanese investments from China to other South East Asian countries is caused by both push and pulls factors – bilateral tensions between China and Japan pushing investments out of the state, and favorable demand and economic conditions of other Asian countries pulling the Japanese multinational companies.

The poor economic performance of China in the recent past has led to increasing costs of living and decreasing income in the economy. As a result, labor costs have increased in the country, especially in the coastal provinces where most multinationals have established their manufacturing plants. In this regard, the shift of foreign direct investments by Japanese companies to neighboring Asian countries is a strategic decision intended to cut costs and increase profits.

Historically, China has been known to produce cheap labor, helping multinational corporations to cut costs. However, Japanese businesses have shifted their focus to low-cost manufacturing countries including Vietnam, Indonesia, Philippines and Cambodia. The problem with this shift to other countries is that the multinationals face significant risks and switching costs. Therefore, there is a high possibility that Japan’s income from foreign direct investments in Asia might decline in the short term, at least before the multinationals can fully adjust in the new markets.

On the other hand, Chinese multinational corporations have shifted their local investments to other countries to take advantage of market opportunities that are diminishing in the local markets. For this reason, Japan benefits from foreign Chinese direct investments, which improve the economic performance of Japan directly. As Chinese firms move to Japan in search for higher returns, Japan receives increased income which adds to the growth in GDP of the country. However, poor economic performance in the home country may affect the multinationals’ business abroad, causing low productivity of Chinese companies in Japan. In the long run, Japan may lose a lot of income due to the unfavorable conditions of China.

Bilateral Trade

The slowdown in the economy of China is also likely to affect the bilateral trade between the two countries significantly. Currently, the amount of exports from Japan to China is decreasing relatively to imports due to the unfavorable market conditions in China (Bajpaee, 2016). As a result, Japan is increasing its trading relations with other countries. China, which used to be the top destination for Japanese products is now third after the United States and South Korea. In this regard, Japan is shifting its focus in terms of exports to other countries with greater potential than China.

Imports from China to Japan amounted to $152 B in 2016, and exports amounted to $116 billion in the same year. All Japanese exports to China fell by 3.5% in September 2017. This was the second straight month that the country experienced a decline in exports due to the Chinese slowdown.

From the figure above, it is clear that the trading partnership between China and Japan has been improving significantly since 2010. Despite the falling economic growth of China, the two countries still engage in significant trade between each other. However, Japan’s exports to China are less than its imports. The exports to China are increasing at a slower rate than the imports as shown in figure 3 above because Chinese demand decreasing with the slowdown in economic growth. According to Hongyong, China is intensifying its exportation business because the local demand and prices are going down (2017). Furthermore, foreign companies are reducing their investments in China due to the slowing economy. The above statistics show that China has been having a good trade with the rest of the world during their economic boom up to 2014, but the trade is declining in the current economic slowdown.

Decline in the economy of China has caused Japanese companies to lose income, which may lead to reduced GDP in Japan. The country depends largely on foreign investments and exports, and the fall in income of its multinationals causes slow growth. A manager of one of Japan’s companies suggests that Chinese customers are holding up (Soble, 2015). They no longer purchase products as they used to during the economic boom in China. In this regard, Japanese companies make lower profits, lay off employees and reduce their tax contribution to the government of Japan.

Tourism

The tourism sector is also performing poorly in Japan. Considering that majority of Japanese tourists come from the U.S. and China, the current economic slowdown of China will cause a decline in Japan’s tourism sector. Because the purchasing power of Chinese people is decreasing after the fall in GDP and income, the locals cannot afford to travel to foreign countries. In this regard, the number of tourists visiting Japan from China decreases significantly. The Chinese tourists are reducing their travels to Japan to cut on spending to adjust to the hard economic times, leading to reduced foreign exchange from tourism in Japan.

Conclusion

Indeed, economic slowdown in China causes ripple effects in other economies. Japan is one of the most affected Asian countries because it is the major trading partner of China. Indeed, the current slowdown of China’s economy is likely to cause decreasing economic performance of Japan through falling demand and investment in China. Japanese firms experience decreased demand for its products in China, leading to reduced income for the companies; hence the tax revenue they contribute to the home country decrease. Furthermore, Japanese exports to China have decreased due to the Chinese decreasing purchasing power, and the number of tourists from China to Japan has also declined. In this regard, Japan’s economy loses income from foreign direct investments, exports and tourism; at least in the short term until it finds new markets in other countries or until the Chinese economy picks up.

References

Acton, G. (2017). China data sparks concerns of a consumer-led slowdown in world’s second-largest economy. CNBC, 15 May, 2017.

Asian Development Bank (2017). Asian Development Outlook (ADO) 2017 Supplement: Cautious Optimism for Asia’s Outlook. [Online] Accessed from https://www.adb.org/publications/ado-supplement-july-2017.

Bajpaee, C. (2016). Japan and China: The Geo-Economic Dimension. The Diplomat, March 28, 2016.

BBC. (2016). China’s Economic Slowdown Deepens. BBC, 12 August 2016.

Drysdale, P. (2015). The geo-economic potential of the China–Japan relationship. East Asia Forum, 28 Sept 2015.

DW (2015). Japan shifting investments from China to ASEAN. DW, 25 July 2015.

Hongyong, Z. (2017). Economic Relations between Japan and China in 2016. Research Institute of Economy, Trade and Industry. [Online] Accessed from http://www.rieti.go.jp/en/columns/a01_0441.html.

Kwan, C.H. (2016). Japan Is Missing the “China Express” While China Is Distancing Itself from Japan. Research Institute of Economy, Trade and Industry, Accessed from http://www.rieti.go.jp/en/china/05021801.html.

Shnider, J.P. (2015). Potemkin on the Pacific. [Online] Accessed from http://www.alhambrapartners.com/2015/04/22/potemkin-on-the-pacific/.

Soble, J. (2015). Japan’s Economy Feels the Sting of China’s Slowdown. The New York Times, Nov 16, 2015.

Trading Economics (2017). Japan Foreign Direct Investment. [Online] Accessed from https://tradingeconomics.com/japan/foreign-direct-investment.

World Bank (2017). GDP Growth [Online] Accessed from https://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG.