Two years after protests, 'China risk' still haunts Japan firms

The Toyota Motor logo is displayed on a vehicle in Beijing, China.
Nelson Ching | Bloomberg | Getty Images
The Toyota Motor logo is displayed on a vehicle in Beijing, China.

Amid a revival in sales of Japanese goods in China and talk of renewed investment from some big firms such as Toyota, a dusty industrial park near Nanjing offers a cold reality check on the health of ties between Asia's two biggest economies.

Despite offering rent-free premises for the first three years to companies expanding to China, the Japan Automotive Parts Industrial Center (JAPIC), set up in Danyang, 200 kilometers (120 miles) west of Shanghai, in 2011, remains near empty.

A visit to the Danyang park, the brainchild of former Toyota Motor executive Kazuo Azuma, challenges the view that Japan Inc's engagement with China is slowly recovering from the shock of anti-Japanese protests that erupted two years ago.

"Do we see any ray of hope?" asks Azuma, who has spent more than 20 years in China, mostly building factories for Toyota. "To be honest, none at the moment. Japan's full of risk-birds chirping, 'China risk.'"

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Azuma's vision was to transplant up to 400 auto parts makers from Japan's industrial heartland, to help them survive the global shift in car demand to emerging economies. China, which is expected to generate annual sales of well above 30 million vehicles by 2020, appears the obvious choice for such firms to establish a base.

But JAPIC has only 24 parts producers in operation – half of what had been envisioned by now.

Azuma and the Danyang local government, which has invested at least 220 million yuan ($36 million) in the project, have called off the second and third phases of construction.

They have also decided to drop "Japan" from the park's name and to try to woo Taiwanese and other suppliers with ties with Japanese producers.

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Can the US help resolve China-Japan tensions?
Can the US help resolve China-Japan tensions?   

Investment slump

Tensions between Tokyo and Beijing spiked in September 2012 after Japan nationalized a small chain of disputed islets in the East China Sea, triggering sometimes violent demonstrations and a boycott of Japanese goods by some Chinese consumers.

Firms such as Toyota, Honda Motor Co and Nissan Motor Co saw sales slump.

Japan's direct investments to China fell nearly 20 percent in 2013 and dropped another 40 percent to 300.8 billion yen ($2.8 billion) during the first half of 2014 compared with a year earlier.

Southeast Asia became a primary destination for Japanese investment, attracting almost three times the amount going to China. During the first half of this year Southeast Asia attracted 878.1 billion yen worth of investments.

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Jing Donggen, a senior Danyang government official in charge of the economic development zone where JAPIC is located, thinks the downturn in Japanese interest is temporary.

"We're confident in this program because there is limited growth opportunity for Japan's small- and medium-sized companies in their homeland," he said.

There is some recent evidence from bigger Japanese companies to support that hope, with the major car makers, for example, seeing some pick-up in sales and making bullish forecasts.

Honda is aiming to boost volumes by 19 percent to 900,000 vehicles this year. Toyota, which is also trying to boost sales by about 20 percent to 1.1 million vehicles in 2014, is considering adding manufacturing capacity again, possibly building a new assembly plant by as early as 2018.

Read MoreToyota Motor aims to double sales in China

Yet smaller companies remain wary.

Kyowa Metal Works Co., a manual transmission supplier in Yokohama, passed up an opportunity to expand its operations in Wuhan in 2012, opting instead for a 2 billion yen move to open a plant near Jakarta.

"If there are political conflicts in China, who knows. We might not be able to repatriate what we have invested," said Chief Executive Masumi Takashima.

Jens Schott Knudsen | Moment Open | Getty Images

Expats leaving

In the short-term, it may not matter much to China that Japanese firms, which have long been the top direct investors in China excluding Hong Kong and Taiwan, are now holding back.

Read MoreChina foreign investment pattern changes as challenges grow

Investors from other economies, including Singapore and South Korea, are eagerly taking up the slack. After two decades of development, China's auto industry is also less reliant on foreign expertise and know-how.

But in the longer run, the slowing Japanese investment could deal a blow to the development of Chinese technology, especially if China looks to expand in more cutting-edge areas, such as hydrogen fuel propulsion.

To be sure, most Japanese companies aren't about to give up on China completely. Many of those who have set up operations at JAPIC remain positive.

Konan Kogyo K.K., a small electrostatic painting company based near Toyota City, began operating a metal painting line in Danyang with 50 workers in early 2012 and is contemplating opening another line to double capacity.

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"It would be a lie if I said we are not concerned about the political tension between Japan and China," says Konan's Danyang-based manager Hiromitsu Ozaki. "But I think we made the right decision to open shop here."

But other evidence from the ground is bleak. In Beijing and Shanghai, there is an exodus of Japanese expatriates and their families, though air pollution and a general economic slowdown are also blamed, along with the political tensions.

The number of Japanese nationals living in Shanghai and neighboring Jiangsu fell 18 percent to 60,300 over the year through October 2013, the first decline since the Japanese consulate in Shanghai began conducting the survey in 1994.

The Japanese school of Beijing's student population has fallen to 480, from more than 600 last year.

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Azuma bemoans that Japanese firms no longer appear capable of looking at China objectively.

"If there are 100 news items about China and 10 are bad, all 10 items would make the evening news, but the rest is ignored because anything negative on China sells in Japan," he said.