Japan's trade with China is booming, but irreconcilable differences persist

• The Sino-Japanese relations remain deeply strained.
• There is no agreement on any of the key open questions.
• Japan cannot isolate its China trade from existential security issues.

Kim Kyung-Hoon | Getty Images

Japanese Prime Minister Shinzo Abe stretches out to Chinese President Xi Jinping during a 2014 meeting in Beijing, China.

On the face of it, the idea of hostility between the two East Asian neighbors is sharply at odds with excellent trade numbers and Japan's unrelenting efforts to keep open the bilateral flows of commerce and finance.

Here is the latest: The Japanese sold to China 35.2 percent of all the goods they dumped on the rest of Asia in the first seven months of this year. And that was a 10.6 percent increase from the year earlier.

For all of 2017, the Japanese export business to China literally flourished, soaring 20.5 percent after a 6.5 percent decline in 2016.

The China business remains the key lifeline to the Japanese economy, where net exports contributed exactly one-third of Japan's economic growth since the beginning of 2017.

Japan's Prime Minister Shinzo Abe was profoundly convinced of that simple truth all along. Here is what he said in his first press conference following his party's landslide victory in December 2012: "China is an indispensable country for the Japanese economy to keep growing. We need to use some wisdom so that political problems will not develop and affect economic issues."

Love thy neighbor

That amounted to the squaring of the circle for a man who forged a veto-proof parliamentary majority on a platform "Take Back Japan" ("Nippon o Torimodosu"), featuring the economic revival through aggressive monetary easing and an export-boosting cheaper yen, a tough line on territorial disputes with China and South Korea and an unacceptably idiosyncratic reading of Japan's history to his Chinese and Korean neighbors.

Abe quickly ran into huge problems with Beijing and Seoul, but, following an apparent trade inertia driven by long-term contracts, and Japan's strong sales efforts, exports to China held up well in 2013 and 2014. The worsening political relations caught up, though, and Japan's China business went on a sharp decline in 2015 and 2016.

Japan, however, did not give up its quest of strong export sales to China against a background of flammable disputes. An unending flow of business and parliamentary delegations kept filing into Beijing seeking "cooperation and understanding," while Abe tirelessly worked for elusive summits with his Chinese counterpart.

Eventually, China began to relent as hostile winds of trade and security were starting to blow across the Pacific after the U.S. presidential elections in late 2016.

So, Abe got some time with China's President Xi Jinping in November 2017 on the sidelines of the Asia Pacific Economic Cooperation (APEC) meeting in the Vietnamese resort city of Da Nang.

"A fresh start," both leaders agreed, with Xi insisting that "constructive steps" must be made to "appropriately manage and control disputes that exist between the two countries."

Indeed. The disputes kept simmering despite a slew of high-level exchanges and empty shells of ritual incantations about mutual benefits from friendly and cooperative relations, while Beijing and Tokyo knew that they were making no progress at all on their irreconcilable differences.

China's growing leverage

And then the political tsunami hit last Tuesday: Tokyo published its defense white paper for 2018. A commentary piece published by Beijing-controlled media outlet Xinhua complained that document included 35 pages of "irresponsible remarks on China's national defense system ... its normal and justified maritime activities in the East and South China Seas ... (and) China's legitimate activities near the Diaoyu Islands (called Senkaku Islands by Japan), which are China's inherent territory in all historical, geographical and legal terms."

Beijing also claims that Japan is exaggerating its China threat, and problems posed by North Korea, to justify its military buildup, with a new missile shield directed at China, and changes to its pacifist constitution. Tokyo was invited to "reflect on its invasion history," to "regain trust from its Asian neighbors."

Particularly intriguing is the Xinhua commentary's pointed trade warning: "Given the uncertainties now facing the global economy, Japan should also cherish the rapprochement of relations with China."

That's a clear sign that Beijing understands its economic leverage because Japan must drastically cut its trade surplus with the United States currently running at a whopping annual rate of $70 billion — roughly unchanged from last year.

Beijing is apparently serving notice that it stands ready to sink some of the $140 billion Japan expects from its goods sales to China by the end of this year. That, and the inevitable cuts to exports to the U.S., would be a formidable double squeeze on Japan's export-driven economy.

Abe, however, remains serene and undeterred in spite of the withering criticism his military doctrine received from China. On Sunday, he told a Japanese newspaper that "the Japan-China relationship has completely returned to a normal track."

He might well get an earful on that when he meets Xi in Vladivostok, Russia during the Eastern Economic Forum on Sept. 11-13. That could be a preview of what he might expect in the course of his visit to China in late October to celebrate the 40th anniversary of the countries' Treaty of Peace and Friendship.

Investment thoughts

A remarkable recovery of Japanese exports to China since the beginning of last year is a result of an apparent political rapprochement of the two countries — against a background of totally unresolved fundamental strategic differences and contested territorial claims.

It is, therefore, not clear to what extent that improbable warming up between Beijing and Tokyo was caused by Washington's changed trade and security policies toward East Asia. Japan may have issues with the U.S. in the area of trade, but, as a friend and ally, Tokyo is part of American efforts to check China's rapidly growing strategic challenge to the Western world order. That is confirmed by the military doctrine enunciated in Japan's white paper on defense for 2018.

China is not fooled by Japan's assiduous courtship to keep open access to the vast Chinese markets. Beijing's constant calls for sincerity and trustworthy relations are all summed up in last week's Xinhua-published statement that Tokyo needs to "make more efforts to enhance mutual trust with Beijing and safeguard regional peace and stability."

Barring an unlikely radical change in Japan's foreign policy and military posture, Tokyo's business dealings with Beijing have no stable and mutually acceptable political foundations.

Commentary by Michael Ivanovitch, an independent analyst focusing on world economy, geopolitics and investment strategy. He 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 Business School.