China and Japan offering a peace dividend

The Chinese and Japanese flags are arranged for a meeting.
Tomohiro Ohsumi | Bloomberg | Getty Images
The Chinese and Japanese flags are arranged for a meeting.

Here is a striking contrast.

A somber looking Mikhail Gorbachev, USSR's last president, wearing a black suit and a black shirt was standing last Friday at "Checkpoint Charlie" on Berlin's Friedrichstrasse, the dividing line of a Cold War Europe. From that heartbreak venue – which he helped to relegate to history – he called on Europeans to stop tearing up the continent and to step back from the new cold war.

That same day the sun was glowing in the Far East: A beaming and a dapper Japanese Prime Minister Shinzo Abe was triumphantly announcing to the nation that he secured a long-sought summit to talk peace with the Chinese leader Xi Jinping on the margins of the APEC (Asia-Pacific Economic Cooperation) meeting in Beijing November 10-11, 2014.

Compared with the hopelessness and desperation in the tortured Europe, the good news from the Orient felt like throwing the hat in the air and screaming "Bravo Asia!"

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Asia's wisdom does deserve a cheer however you choose to do it.

To be sure, that carefully prepared Xi-Abe meeting will be long on symbolism and short on new substance, because its ground rules are based on Japan's commitment to abide by the existing Sino-Japanese agreements concluded in 1972, 1978, 1998 and 2008.

But in this case the symbolism matters greatly, starting with prominently displayed pictures of the Chinese schoolchildren waving Japanese flags – a message of hope and friendship to the Japanese public where an opinion poll conducted last September showed that 93 percent (sic) of the people interviewed had a negative view of China.

And it will be a world of difference to see the Chinese president extending the courtesy to the Japanese leader, compared with the pictures of daily hostile encounters where the two countries' air and naval assets are playing the game of chicken in the East and South China Seas.

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Japan needs a quick shot of China business

In his first press conference as a newly elected prime minister, Mr. Abe was quoted as saying on December 26, 2012 that "China is an indispensable country for the Japanese economy to keep growing."

That was hardly an overstatement. China is by far Japan's largest trading partner. In the first half of this year, the two countries' bilateral trade rose 12 percent from the year earlier, and was 54 percent bigger than Japan's trade with the United States. In spite of that, the deteriorating political ties have taken their toll on business confidence: Over the same period, Japanese investments to China are estimated to have declined by nearly 50 percent.

A quick resumption of strong business with China is crucially important at the time when Japan's attempts at a long-delayed fiscal consolidation have brought private consumption to a standstill (a puny 0.5 percent growth in the first half of this year). The booming housing demand was also abruptly brought to an end with a 2 percent decline in the second quarter.

China can help to boost Japan's exports and corporate investments – the country's traditional growth engines that feed off each other. Foreign sales and business capital outlays represent about 30 percent of Japan's gross domestic product (GDP). They are the only components of private sector demand that have maintained a strong forward momentum in the first half of this year.

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The question now is: Are the Sino-Japanese relations likely to improve to the point that would rescue the Japanese economy from its current deadlock?

I doubt it for two main reasons.

First, Japan's American, European and Korean competitors have taken China's market segments Japanese companies either could not cover or had to abandon due to sharply deteriorating Sino-Japanese political ties over the last few years.

Also, China's import-competing industries are becoming much more efficient, and the Chinese regulatory authorities are now more selective with respect to investments and products offered by foreign companies. American and European businesses have been complaining for some time about obstacles to market access, and about problems of operating in China. These issues have become so serious that their discussion has been elevated to the highest levels of China's bilateral relations.

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Let's keep talking is not what China wants

Second, as things stand now, I don't see how China and Japan can smooth out their fundamentally clashing political and security interests. Their competing territorial claims are just one of the symptoms of their seemingly irreconcilable differences.

To begin with, Mr. Abe is now telling Mr. Xi to put the issue of contested maritime borders to the side, while assuring the Japanese people that the disputed islands in the South China Sea are non-negotiable because they are part of Japan's sovereign territory. If that is all Mr. Abe is bringing to the table, then what's the point of the summit other than Mr. Xi's polite gesture to extend courtesy as a host of the APEC meeting?

And then there are trade and investment issues where China and Japan have competing interests. For example, the China-sponsored Asian Infrastructure Investment Bank (AIIB) has been joined by 21 countries, but Japan is not one of them. Also, what will Japan's response be to the Free Trade Area of the Asia-Pacific (FTAAP) promoted by China at the time when Mr. Abe is telling Washington that he is pushing hard to join the U.S.-led Trans-Pacific Partnership (TPP)?

China's Asian projects are directly competing with institutions (such as the Asian Development Bank) and trade agreements led by the United States and Japan.

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And then, how will Mr. Abe handle his official position that China is Japan's main strategic threat? A reminder of that are the currently held massive U.S.-Japan military exercises -- code-named the "Keen Sword" and running until November 19, 2014 – with more than 40,000 soldiers, 25 warships and 260 airplanes. Beijing will be particularly piqued by the part of the exercise intended to protect an uninhabited part of Amami Islands from parachuted enemy forces.

Investment thoughts

It seems that Japan is trying to square the circle in its strained relations with China.

China has agreed to security arrangements with Japan to avoid escalating tensions, but its high-ranking officials sound skeptical about improved relations. Through its state-run news agency, China is calling on Japan "to adhere to future agreements and to show sincerity."

Beijing probably thinks that time is on its side and that, according to Sun Tzu, "The supreme art of war is to subdue the enemy without fighting."

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I believe that China's apparent choice of a peaceful approach to intra-Asian relations holds a great promise for the region's economic growth and strong investment returns.

Michael Ivanovitch is president of MSI Global, a New York-based economic research company. He also served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York and taught economics at Columbia.