History and geography have intertwined Japan and China for centuries, but recent Chinese economic expansion has prompted both countries to see each other in a new light, writes Kenichi Kubo
Chinese corporations are increasing their global presence thanks to cost competitiveness and robust domestic demand. Enthusiasm for Japanese companies and their technological capabilities is also increasing in China.
At the same time, as Japan’s population shrinks and income levels in China rise, many Japanese companies are aiming to benefit from the subsequent increased demand for high quality products. Environmental and energy-efficiency related fields also look promising for Japanese companies.
In this economic environment, what sectors are benefiting from this relationship?
Japan from China’s perspective
Previously Japan was a provider of capital and employment. Before its recent growth, China had suffered from inflation and subsequent disinflation in the 1990s. The unemployment rate was around 2% 15 years ago, but increased to the 4% level five years ago. At the same time Japanese corporations also started to move into China, and the number of Chinese subsidiaries of Japanese corporations increased from 900 in FY 1995 to 5,100 in FY 2008. The number of employees at these subsidiaries also increased from 230,000 in FY 1995 to 1,150,000 in FY 2008, contributing to job creation in China.
Following that, Japan became an example for China of how to produce high-quality products, and it still is today. Chinese corporations have the advantages of abundant labour and cost competitiveness, but have faced challenges in quality improvement, manufacturing productivity, and safety and health. In these areas China is closely watching the high quality of Japanese products. In high-end hotels in Shanghai, for example, toilet fixtures are made in Japan, not China. Consumer trust of upper-end Japanese products in the cosmetics market is high. Investment in Japanese companies that provide reliable high-quality products and services is another option for investors to capture China’s economic growth in addition to investment in local corporations.
Going forward, we will enter the stage where China imports technology from Japan. China’s share in the world nominal GDP is 8%, while its share of greenhouse gas emissions is 19%. In contrast, Japan’s share of nominal GDP is the same as that of China, while its greenhouse gas emissions share is only 4%.
Three areas I think will be of particular interest to China are clean coal, recycled energy, and air/water purification. The source of 70% of China’s energy is coal, and cleaner and more efficient energy will be an important challenge for China. As an alternative, integrated gasification combined cycle (IGCC) technology is 8% more efficient than ordinary coal-fired plants and can reduce carbon dioxide emissions by 30%. IGCC is still in the experimental stage, but this sort of modern environmental technology is something at which Japan excels.
Air and water quality issues are also points of focus as China rapidly develops. Chinese energy consumption is expected to double by 2030, and the combination of Japan’s energy efficiency expertise and China’s increasing energy consumption will not only help resolve global warming issues but will also expand corporate profits. Japan’s world class waste disposal technology also has room to expand its presence in China.
China from Japan’s perspective
From Japan’s point of view, China was first a manufacturing centre. Japanese companies focused on increasing profits by producing goods in China and then exporting them to the US and Europe. The minimum wage in China, however, has quadrupled since 1995, and it is becoming harder to find staff in the coastal regions. More corporations could start to manufacture in other Asian countries such as Vietnam, Cambodia, and Myanmar instead of China.
China is currently shifting from a manufacturing centre to a consumer and export market for Japan. China’s per capita nominal gross GDP has risen to over $3,000, with levels in Beijing over $10,000 and in Shanghai over $20,000, and it is likely Chinese consumer spending will surge. Twenty years ago Japan’s exports to China were less than one tenth of the value of exports to the US. Even 10 years ago, exports to the US accounted for 30% of Japanese exports while exports to China were only 5%. Currently, however, China has surpassed the US to take the biggest share of Japanese exports.
Japanese industries such as machinery, manufacturing, and water treatment are promising. Non-manufacturing industries, however, are also doing well. For example, a chain of beef and rice bowl restaurants now has over 200 locations in China, already more than in the US. Department stores and general merchandisers that distinguish themselves with their Japanese style customer service are also steadily increasing their presence. Three large chains of convenience stores utilising operational know-how developed in Japan now have a total of 800 stores in China.
The next stage is for China to be as an essential part of Japan’s tourism market. When Japan moved from a fixed exchange rate system of 360 yen to the dollar to a floating system, there was a sudden increase in the number of people who traveled overseas because of their increased purchasing power. As China’s economic growth brings increased income, and if the renminbi strengthens and increases purchasing power, I think it is likely more Chinese will travel overseas, especially to other Asian countries. While visitors from Korea dropped 33% and visitors from Taiwan dropped 26% in 2009 due to recession, Chinese travelers increased to reach one million during this same time period.
Previously Chinese tourists were allowed to visit Japan on group tours only, but since August 2009 individuals who fulfill certain income requirements can receive individual tourist visas at diplomatic missions in Beijing, Shanghai, and Guangzhou. The Chinese Government is currently considering relaxing these restrictions even further. Japan also has high hopes for these tourists. Despite widespread cuts in government budgets, the FY2010 budget for the Japan Tourism Agency was increased 2.6 times compared to the previous year (including a budget for promotion in China of ¥2.5bn, a tenfold increase over the previous year). For the next few years the economic effect of this may be limited, but five to 10 years down the road this could result in the consumer spending of Chinese tourists propping up the Japanese economy. This will affect industries across the board, including retail and home electronics, travel and leisure, restaurants, animation, transportation, and services.
As a result of the overseas expansion of Chinese and Japanese companies and increased interaction between companies, from a top-down point of view we will need to focus on shifting to a country-to-country comparison from a GDP base to GNP base. A second effect is bottom-up, where I think global competitiveness will become more important for companies than their positions among domestic competitors.
Whether China as a global economic driving power and Japan as a gateway to investment in Asia can sustain and increase their presence in world markets is something investors will be watching closely.
Kenichi Kubo is Japanese equity chief portfolio manager at Tokio Marine Asset Management
