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China and Japan have long, close ties, that even WW2 sensitivities can't shake

Japan's Prime Minister Shinzo Abe (left) shakes hands with China's President Xi Jinping (right), during their meeting at the Great Hall of the People in Beijing, China.
Kim Kyung-Hoon-Pool | Getty Images
Japan's Prime Minister Shinzo Abe (left) shakes hands with China's President Xi Jinping (right), during their meeting at the Great Hall of the People in Beijing, China.

China and Japan may have a frosty political relationship since after the Second World War, but the East China Sea neighbors are thick as thieves when it comes to trade and investment.

Economic cooperation between the two economic heavyweights started as early as 1948 to 1949, and the first unofficial trade agreement followed in 1952.

"The Chinese Communist Party viewed Japan as an important source of industrial goods technology and expertise which were vitally important in helping to rebuild and modernize the Chinese economy after 1949 [while] Japan saw China as an important source of raw materials," said Amy King, lecturer at the Australian National University's Strategic and Defence Studies Centre.

"China and Japan went on to sign four trade agreements in the 1950s and 1960s, despite the fact that they had no diplomatic relationship and by 1965, Japan had become China's most important trade partner," said King, who is also the author of "China-Japan Relations after World War Two: Empire Industry and War, 1949-1971."

Mutually beneficial trading partners

Trade relations between China and Japan have been "largely complementary and hugely beneficial for both sides," said Martin Schulz, senior research fellow at Fujitsu Research Institute.

"The benefits might not be equal, but they are mutual and have resulted in higher incomes on both sides," the academic said, adding that the gains were more apparent in some industries than others.

For example, "China's automobile market is much more important to Japan, and could not be replaced by demand in other countries, and vice versa, Japan's agriculture market is more important to China," Schulz said. "Interestingly, exports of automobiles from Japan to China are largely the same size as agricultural products from China to Japan."

Japan is China's third-largest export destination and its fourth-largest import origin, while China is Japan's second-largest export destination and Japan's top supplier for imports, Harumi Taguchi, principal economist at IHS Economics told CNBC.

But as China's economy slows, it has inevitably had a negative impact on Japan's exports.

In May, Japan's industrial output fell 0.4 percent year-on-year, and exports declined 11.3 percent for the eighth consecutive month. Shipments to China fell the most by 14.9 percent, followed by South Korea.

Japan's exporters have also had to deal with the strong yen, which makes exports more expensive and dampens overseas profits.

Foreign direct investment

China and Japan have also shared a strong foreign direct investment relationship; 8.8 percent of total Japanese foreign direct investment (FDI) went into China last year, according to data from Natixis. This was only surpassed by U.S., which accounted for the most Japanese FDI.

China's manufacturing sector accounted for 66 percent of Japan's FDI into China in 2015, however rising wages in China have been squeezing profit margins, said Kohei Iwahara, economist at Natixis Japan Securities.

"Japanese manufacturers, especially for lower-end goods are starting to transfer their production from China to Asean economies such as Vietnam and Thailand," Iwahara told CNBC.

China's FDI into Japan has also been subdued, falling by 27.6 percent in 2015 from a year ago, according to Japan External Trade Organization statistics.

Deep-rooted cultural heritage

But despite the economic bonhomie, several thorny issues are yet to be resolved, ranging from World War II Japanese war crimes committed in China to territorial disputes in East China Sea.

"On security issues, Japan sees China as taking more provocative steps to assert China's 'rights' at sea, and Japan is steadily increasing its defense interactions around the region, particularly with the Philippines," said Rodger Baker, vice president of strategic analysis at Stratfor.

"From China's perspective, [Japan's defense interactions] are evidence of the remilitarization of Japan, something Beijing sees as backed, if not instigated, by the United States," he added.

The neighbors' latest falling out came about in June when Japan complained that China had escalated its military activities in the East China Sea, a group of islands embroiled in a territorial dispute between Japan and China.

Beijing has also accused Tokyo of interfering in the South China Sea, of which Japan is not a claimant.

On July 12, The Hague rebuffed China's claim to a portion of the South China Sea and ruled that the disputed territory belonged to the Philippines. China refused to acknowledge the ruling, even after Japan and Western countries had called for China to respect it.

Last week, Chinese Premier Li Keqiang told Japanese Prime Minister Shinzo Abe that Japan should stop interfering in the South China Sea issue, reported Reuters.

Stratfor's Baker explained that "although China argues that Japan has no role in the South China Sea, most of Japan's supply lines pass through these waters, which is significant given the resource scarcity in Japan."

Japan: Chinese tourists' haven?

Despite the political tension, Chinese tourists are still going across the East China Sea and holidaying in Japan in large numbers.

The rise of China's middle-class and consumption has actually benefitted Japan, with Chinese visitor arrivals up 107.3 percent year-on-year in 2015, and nearly six-fold from a decade ago, according to Japan National Tourist Organization, making China the largest visitor group to Japan by nationality.

A March survey by Japan's largest travel agency JTB found that the most popular reason Chinese visitors head to Japan is to "see Japan as a developed Asian country" followed by "to eat Japanese food in Japan."

Perhaps understanding Sino-Japanese ties is to acknowledge that "there is a key contradiction at the heart of the China-Japan relationship," explained King from the Australian National University.

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