Will the Japanese Tragedy Enshrine China’s Regional Hegemony?

It is important not to underestimate the importance of Japan to the rest of East and South East Asia. Despite the much-vaunted rise of China as an economic powerhouse, Japan remains a critical component of regional trade, investment and the increasingly more complex production systems (Figure 1). Indeed, Japanese external activity has become progressively more focused on Asia, which in 2010 accounted for 53.4% of exports, 42.5% of imports and 26.3% of investment outflows. In addition, Japan supplies major funding through its aid and export credit agencies and the Asian Development Bank. It may well be that Japan’s contributions in all these areas will become squeezed as resources are directed at domestic reconstruction. This would have significant consequences for, in particular, the South East Asian economies, which are heavily export dependent and endeavouring to upgrade their production facilities and infrastructure. This in a period when maintaining their competitive edge is becoming increasingly challenging.

In terms of production systems, Japan remains the principle regional supplier of technical and management knowhow, machinery and key components, including microchips, and a critical link between regional producers and extra-regional markets. It is clear that the disruption of Japanese production is already creating major problems that have been particularly commented on with respect to motor vehicles and electronics, but clearly goes well beyond these sectors. There are also concerns that Japan will significantly increase its imports of oil and gas to compensate for the 11 closed nuclear plants, 4 of which have been condemned and the reopening of the rest looking more and more remote as the Fukushima disaster continues to unfold. While increased demand for oil and gas may benefit Indonesia and Vietnam, the principle regional exporters, price rises would be an unwelcome consequence for the importing majority. More generally, in order to fund reconstruction, compensation and insurance claims, Japan might need to liquidate a large volume of overseas assets, which would push up the value of the Yen. This would put pressure on those parts of the regional production system that are dependent on Japan either as a source of key materials or as the final exporter of their products. Additional problems would be faced by those countries with significant debt held in Yen – notably Vietnam; a situation that could well be compounded by a reluctance of Japan to purchase further amounts of government bonds. While it may be that most of the direct consequences of the events in Japan prove to be short-term, many have the potential to have long-term consequences for the Asian region.

Much of course depends on the speed and extent of the Japanese recovery and it is clear that there is both the capacity and resources to reconstruct. Despite twenty years of slow growth, saturated markets, budget deficits and escalating public debt, Japan has maintained high levels of trade and balance-of-payment surpluses and has continued to accumulate substantial central bank reserves. Nonetheless, the World Bank has suggested that reconstruction and recovery of production will take 5 years.

Heavy investment in reconstruction will undoubtedly stimulate the Japanese economy and spill over into the wider Asian region. This may be offset, however, by the effects of adding to a sovereign debt which is already nearly the equivalent of 200% of GDP and the loss of income resulting from the sale of overseas assets. Perhaps more seriously, the disruption of the Japanese operating environment, particularly with respect to power generation, may accelerate the already significant trend towards off-shoring. This has come to include high-tech activities, including R&D, with China by far the most important destination. There are here some significant long-term implications for Japan’s employment, economic structure, trade surplus and economic growth.

It is clear that China would be by far the greatest beneficiary of any Japanese retreat from production, funding and ownership in East and South East Asia. China has already established itself as a major player in the regional production system. This is being furthered by the remarkably rapid rate at which China is climbing the technological ladder and developing its regional investment and funding roles. Thus, a protracted period of Japanese recovery and preoccupation with domestic affairs could prove pivotal in the shift of regional economic power and leadership to China. Such a development would be further accelerated if there were to be another significant regional or extra-regional crisis that demanded rapid and coordinated action on the part of the East and South East Asian economies. Such an event could see China emerge as the principle funder and driver of regional growth and integration. Thus, the Japanese tragedy may be China’s regional opportunity.

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