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Shinzo Abe’s Challenge to China


by

Peter Tasker

Published in Policy Options 26/11/2013

“BUY my Abenomics!” was Japanese Prime Minister Shinzo Abe’s exhortation from the podium of the New York Stock Exchange one day last September. If even Gordon Gekko could make a comeback, Mr. Abe said, referencing the fictional financier who became an icon of greed and profits in the 1980s, so can countries. “Japan is back” the prime minister declared before ringing the Exchange’s closing bell.

So far, so good. Since the day in November 2012 that Mr. Abe launched the bold reflationary economic programme that bears his name, foreign investors have poured a record $110 bn of capital into the Tokyo stock market. In US dollar terms, the Nikkei Index currently stands at its highest point since the turn of the century.

The public has bought in too. Mr. Abe’s poll ratings remain astonishingly high for a Japanese leader in his second year and he has won resounding victories in both the Lower House and Upper House elections in the space of nine months. With Japanese GDP growth humming along at a best-in-show 4% in the first half of 2013, he has put his stamp on events in a way that leaders of many other countries can match only in their dreams.

Economically, the progress to date has been as smooth as a ride in one of the new double-decker bullet-trains. Yet the ultimate purpose of the Abenomics project is not economic. It is an attempt to restore Japan’s influence as a global player; to strengthen its geopolitical profile; to change the strategic dynamics of the East Asian region.

If he succeeds, the impact will be felt for decades to come. Arresting the country’s economic decline is essential if Japan is to counter-balance Chinese power in Asia and beyond. It begins with reviving a national confidence enfeebled by years of sluggish growth and political paralysis.

Abenomics is Japan’s attempt to reverse the tide of events by arresting Japan’s slide both economically and strategically. If it is successful, for the first time in history Japan and China will be major players at the same time – a prospect that offers  plenty of risks as well as opportunities.

 

IT was just a year ago that China and Japan both saw big changes at the top. Understandably, most of the world’s attention focused on the appointment of Xi Jinping as General Secretary of the Chinese Communist Party, given a touch of extra drama by the still-unexplained “disappearance” of the heir apparent a few weeks before his confirmation by the Central Committee.

In all likelihood Mr.Xi will be in the driving seat of the world’s most populous nation and fastest-growing economy until 2025 – without, of course, having the inconvenience of election campaigns, unfavourable poll ratings and regular lambastings in the press.

The contrast with Japan could not have been starker. When Prime Minister Shinzo Abe took office, there had been six prime ministers in the previous six years, none of whom had achieved anything of note. The first in this inglorious sequence was none other than Mr. Abe himself. No surprise, then, that his re-emergence was greeted with weary shrugs, rather than anticipation.

The contrast in economic fortunes and geopolitical presence was equally telling. Two decades after the bursting of the economic bubble, Japan appeared trapped in deflationary stagnation – nominal GDP was no higher in 2012 than in 1992. Some of the great names of Japanese manufacturing such as Sharp, Panasonic and Sony were in a near-terminal state of uncompetitiveness relative to Samsung, Foxconn and other stars of rising Asia.

Japan, it seemed, was yesterday’s story and resigned to its fate of steady, if polite decline. China had displaced it as the world’s second largest economy and was moving inexorably to a position of regional and potentially world dominance.

It was a microcosm of a broader theme that seemed especially resonant after the global financial crisis of 2008 – the decline of the aging, over-leveraged, over-consuming developed world and the rise of the emerging economies, led by China and the other “BRICs”.

Today the picture is a lot more complex. Political and social strains have become apparent across the emerging world as growth has undershot expectations. Amongst the BRICs countries, the reversal of fortune in India and Brazil has been especially intense. The idea that Egypt would be one of the world’s ten largest economies in 2050, as respected analysts at Citi predicted in 2011, now seems merely bizarre.

China is still posting the highest growth numbers in the world, but it is embarking on what is likely to be a long and delicate process of transition – from an economy reliant on super-charged, government-directed fixed asset investment to a more sustainable model based on household consumption. The most likely scenario is for growth to ratchet down from the double digits levels of the last twenty years to the 3-7% range.

Some other East Asian countries have accomplished similar re-balancings, but not without upsets along the way. Early 1970s Japan was a hotbed of terrorism and social unrest, as symbolized by the bloody battles over the construction of Narita Airport. For South Korea the late 1970s and early 1980s were marked by political assassinations, martial law and the Gwangju massacre.

The political risks to China’s transition from rapid to manageable economic growth are formidable. The breath-taking wealth divide that has opened up between the elite and the average citizen far surpasses anything seen even in the far-from-egalitarian United States.

Despite China’s phenomenal growth of the last 20 years, the average American is still eight times richer than the average Chinese citizen. Yet the wealth of the Chinese leadership dwarfs the American equivalent. According to an analysis by Bloomberg, the net worth of the 70 richest members of China’s National People’s Congress was roughly $90 billion as of early 2012. By comparison, the combined net worth of the 535 members of the US Congress, the president, his cabinet and the Supreme Court judges amounted to $7.5 billion. Bloomberg found its websites blocked in China after reporting on this super-sensitive issue.

Trends in China’s foreign reserves over the past few years are suggestive of significant capital flight – which would match the disguised flight in human capital evidenced by the elite’s predilection for having their children educated overseas. What this means at a personal level was revealed to the world and the Chinese public by the spectacular downfall of Bo Xi Lai and his wife Gu Kai Lai. The trigger event, so to speak, was Gu’s murder of Englishman Neil Heywood who, amongst other services rendered, introduced the couple’s son to his alma mater, Harrow.

Just as the challenges facing China and other developing economies tended to be underestimated during the BRICS boom of the past decade, so were the strengths of the developed economies – and Japan in particular.

From the mid-1990s onwards Japan had been the recipient of a great deal of free advice from the West, and the United States in particular, on how to deregulate, reform and re-energize its economy. The underlying message was always the same – “be more like us.” Not all the recommendations were misguided by any means, but they tended to ignore something that has become crystal-clear since the Lehman Brothers shock of 2008. The collapse of an asset bubble changes reality significantly and for the worse. Growth suddenly becomes very hard to come by.

Comparing the recent US housing bubble with the Japanese bubble of the 1980s is like lining up the Incredible Hulk with Godzilla. The scale is simply different. On some reckonings, the collapse of the Japanese real estate and stock markets in the 1990s wreaked more damage on the national balance sheet than the second world war.

Given what we know now about the difficulty of post-bubble adjustments, Japan’s economic performance of the last two decades looks very different. The sudden shift from solid growth to stagnation looks less like a feeble dunce-of-the-class effort than a reasonable achievement under the circumstances. If Ireland, Spain and Greece could trade Japan-style flat-lining for what actually happened to them post-2008, they would surely jump at the deal.

Although the Japanese consumer electronics is a shadow of its former self, the auto industry has come roaring back to peak profitability. There are still plenty of Japanese companies – including some medium-scale enterprises – which are world leaders in their fields. And Japan’s reserves of social capital remain unmatched, as was demonstrated by the public’s disciplined response to the 3.11 triple disaster of earthquake, tsunami and nuclear meltdown.

Can Japan regain its animal spirits and reconfigure itself for the realities of the early twenty first century? It seemed an unlikely prospect until the dawn of Abenomics.

 

THE political innovator who spawned Abenomics is a different order of phenomenon to the underwhelming conservative, also known as Shinzo Abe, who served as prime minister for an unmemorable twelve months in 2006-7.

Whereas Abe 1.0 never showed any interest in economics, Abe 2.0 sounds like he has just completed a masters in finance at the University of Chicago. Abe 1.0 was a cultural conservative who seemed to believe a woman’s place was in the home and schools should teach patriotism and traditional ethics. Abe 2.0’s targets include boosting child-care facilities to help increase female participation in the workforce, encouraging more young Japanese to study overseas and having more than 10 Japanese universities ranked in the global Top 100 within the next ten years.

Abe 1.0 was keen to hold on to the rural vote and showed no sign of opening up Japanese agriculture, the mainstay of communities that are bastions of conservative support. Weeks before the Upper House elections, Abe 2.0 announced that Japan was joining the Trans Pacific Partnership, a nascent free trade agreement that includes many Asian and Pacific basin countries, but not China. Suddenly Japanese agriculture subsidies were on the table.

Japanese politics is driven not by individuals, nor even by parties, but by coalitions of interests that must include powerful figures in the bureaucracy, business world and media if there is to be any chance of success. If Mr. Abe’s thinking has changed, it’s because the thinking of the people behind him has changed. Engagement and opening have become priorities. Or to put it the other way round, isolation has begun to look a lot more risky

Why? The answer lies across the East China Sea.

The key event in the transformation of Abe 1.0 into Abe 2.0 was the escalating dispute between Japan and China about the tiny chain of islands knows respectively as the Senkaku and Diaoyu. The Japanese claim goes back to the 1890s when, the way the Japanese tell it, the islands were uninhabited terra nulla. The Chinese version has their claim going back centuries, to the appearance of the islands on official maps.

When China and Japan restored diplomatic relations in 1972, Deng Xiaoping agreed to shelve the Senkaku/Diaoyu issue for the next generation to solve. In the first decade of the twenty first century, that generation had arrived. China was ready to flex its buff new muscles and exact redress for the century of humiliation it had endured at the hands of Japan and the West. Deng-style pragmatism was out and hardball was the name of the game.

When the skipper of a Chinese fishing boat was arrested after a clash with the Japanese coast-guard, the Chinese government’s response was immediate, aggressive and highly effective. An embargo was imposed on the export of rare earth metals, vital for Japanese industry and supplied almost totally by China. Japan faced the choice of making a humiliating climb-down or seeing production slump in its auto and electronics industries. It plumped for the former.

The flare-up of tensions in September 2012, just two months before Mr. Abe’s comeback, was even more alarming from the Japanese perspective. Rioters torched a factory belonging to Panasonic, the first Japanese company to set up in China after normalization. Consumer boycotts took a huge chunk out of the markets shares of Japanese auto companies. Worse, the eruption of rage seemed to have official imprimatur in a way that previous spates of anti-Japanese unrest had not. Some highly-placed Chinese officials even went so far as to question Japanese sovereignty over the entire Ryukyu chain, which includes Okinawa.

Abe 1.0 and Abe 2.0 have one characteristic in common. On national security, they are both hawks. Specifically, they both want to revise Japan’s American-written pacifist constitution to allow collective self-defence. This would turn the US-Japan security relationship into a true alliance rather than the one-way commitment to protect that it is at present. It would make other security agreements feasible too.

Abe 1.0’s views achieved little traction. At the time, Japan’s pro-China business lobby was in the ascendancy. After the global financial crisis of 2008, the economic logic became even more compelling as the US auto market collapsed while China set off on a wild infrastructure spending spree. The political movement was in the same direction. Abe’s Liberal Democratic Party lost the monopoly on power it had enjoyed for fifty years. It was replaced by the Democratic Party of Japan whose leadership included men with pacifist, pan-Asian leanings and less than total enthusiasm for the US alliance.

The Senkaku / Diaoyu fiasco changed all that. In the political world the leaders of the DPJ went from heroes to zeroes in record time and their party was effectively annihilated in the election of December 2012, when Mr. Abe returned. Corporate Japan began to make alternative arrangements for overseas production bases. In the first six months of 2013, Japanese direct investment into the ASEAN countries exceeded direct investment into China for the first time ever.

Japanese prime ministers rarely come back from political oblivion, but cometh the hour cometh the man. Shinzo Abe owes his second bite of the persimmon to a string of tiny uninhabited rocks equidistant between Taiwan and the southern Ryukyus.

Essentially Abenomics is a product made in China.

 

FUKOKU kyohei, meaning “rich country, strong army,” was the motto of the leaders of the Meiji Restoration, the great change of 1868 that kicked off the headlong modernization of Japan.

Nineteenth century China had been unable to resist the encroachments of the Western powers and ended up being sliced into pieces like a Peking duck. The samurai of the Satsuma and Choshu domains who toppled the Tokugawa shogunate and “restored” the emperor (in reality used him as symbolic cover for what amounted to a coup d’etat) understood that a different approach was required.

If the West’s military superiority was based on technological and economic advances, then the only way to secure independence was to copy those sources of strength. In other words, Japan had to buy into the prevailing world order. If that meant that the samurai would have to give up their swords and go to work in government offices, that the higher echelons of society would have to learn to foxtrot, that there would have to be political parties and a free-ish press – then so be it.

Ironically the fukoku kyohei slogan, like many elements of Japanese culture, was originally a borrowing from ancient China, specifically the Warring States period (470-220 BC). However China appeared to have forgotten the lesson from its own golden age. Under the Qing dynasty and again under Mao Tse Tung, China’s adopted a “poor country, strong army” strategy. The result in both cases was social collapse and chaos.

Japan’s extraordinary success in integrating Western knowledge and systems achieved the required result. Thanks to rapid industrialization, Japan could number itself amongst the rich countries and for the first time it had a military strong enough to project force overseas.

The late nineteenth century was the zenith of colonialism, often justified by theories of racial hierarchy loosely based on Spencerian ideas of the survival of the fittest. The European powers, from Great Britain to tiny Belgium, had acquired colonial empires. The United States gobbled up Hawaii, wrested the Philippines from Spanish control and had already marked out Central and South America as its special sphere of influence. The “uncivilized” areas of the world were all up for grabs. It was just a question of who got what and when. How was rarely an issue.

Japan came late to the imperial party that had created the West’s great colonial empires. But it was a fast learner. It won two territorial wars in the space of a decade, showcasing its new military strength and geopolitical ambitions. First it fought a successful war against China in 1894-5 over the control of Korea and then absorbed Taiwan. Ten years later it went to war with Russia over competing interests in Manchuria. When Japan’s Glasgow-made warships sank the Russian navy in the Straits of Tsushima in 1905, it marked the first Asian victory over Westerners since the Mongol armies laid siege to the gates of Vienna in the thirteenth century.

From our vantage point of knowledge about what happened in the 1930s and 1940s, we might judge these early examples of Japanese aggression as first steps on the road to national disaster. But that’s not how it seemed at the time. Japan was merely using the template established by the world’s leading powers. It showed its allegiance to the Anglo-Saxon world order when it declared war on Germany in 1914 and grabbed its small collection of Asian colonies. The same applied in 1918 when Japan made a large-scale incursion into Siberia as part of the Anglo-American-Franco military campaign against the Bolsheviks.

Japan had formally become a member of the insiders’ club in 1902 when it signed an alliance with Great Britain, still the world’s dominant power. Only when that alliance was dissolved in 1923 did Japan become “unclubbable.”

Prime Minister Abe explicitly referenced this golden era of fukoku kyohei in the opening remarks of the speech he gave at the London Guildhall in June. He told the story of Korekiyo Takahashi, “the Keynes of Japan”, who came to London in 1904 to arrange the flotation of the bonds that would finance Japan’s war against Czarist Russia. Mr. Abe’s speech-writer had dug out the fact that one of Takahashi’s counterparties was Sir Ewen Cameron, London head of the Hong Kong and Shanghai Banking Corporation and great-grandfather of Britain’s current prime minister. It was an adroit way of highlighting the long history of Japan’s engagement with financial capitalism and the personal connections that came with it.

Mr. Abe went on to say that Takahashi’s reflationary policies in the 1930s were the inspiration for Abenomics. But before going on to give chapter and verse on his own ideas for economic recovery, he made another sharp political point. Japan, he noted, granted universal suffrage to males in 1925, just seven years after Britain.

The not-so-subtly implied contrast was with countries which have yet to reach the same level of democratic development ninety years later.

 

NEVER in history have China and Japan been strong at the same time. Until the nineteenth century China was the dominant power to which its smaller neighbours paid tribute. Japan’s sun rose with the Meiji Restoration. Over the next hundred years Japan grew to become the world’s second largest economy, while China reeled from disaster to disaster.

Then from 1990 onwards, it looks if another reversal of fortune was underway. After the collapse of the bubble economy, Japan slid into deflationary stagnation at the very time that was China astonishing the world with two decades of super-charged growth, lifting hundreds of millions of its citizens out of poverty in the process.

Abenomics is Japan’s attempt to reverse the tide of events and arrest Japan’s slide both economically and strategically. If it is successful, for the first time in history Japan and China will be strong simultaneously.

The logic of numbers guarantees that China will become the world’s largest economy sometime in the next decade and that in itself bestows great influence and power. However a re-energized Japan would still be major force, particularly if allied with the United States and India, thus creating a Triple Entente whose combined economic scale would far exceed China’s. The ability to make alliances, form trading blocs and project soft power will be crucial to the twenty first century version of fukoku kyohei.

In his nicely judged speech at the Guildhall, Mr. Abe didn’t touch on what happened to Anglo-Japanese relations after Korekiyo Takahashi was assassinated by ultra-nationalists in 1936. Nonetheless it must have been in the minds of his audience. Japan’s challenge to China is not just that of a competitor and strategic counterweight. Japan’s own historical trajectory offers the clearest example of the great benefits of conforming with global norms and the disastrous consequences of rejecting them.

 

REVISION of the Japanese constitution remains one of Mr.Abe’s key political projects. Opinion polls suggest that the Japanese public is divided on the issue, but there is a strong belief in parts of Japan’s establishment that it must be allowed to negotiate new military partnerships and alliances. Every time the Chinese leadership steps up the bellicose rhetoric, that view gets more traction amongst the public.

Mr. Abe’s bullish words at the New York stock exchange were not just aimed at financial professionals, or at the Japanese public alone. He was asking the world to buy into the world-view behind it, of a Japan no longer passive, self-absorbed by its own decline, ready to play a role as a responsible global power. It is a message aimed, too, at the powers-that-be in Beijing.

It is hard to tell how China, newly recovered from its age of darkness, will respond over time to a Japan willing to assert its claim to major power status. But there is no reason why China’s various territorial quarrels with neighbouring countries should not be handled diplomatically, as are Japan’s long-running island disputes with Russia and South Korea, rather than by force majeure. Likewise, there is no reason why China should not join the Trans Pacific Partnership – if it could clean up its act on intellectual property and reduce subsidies to state owned enterprises.

Ultimately there is no reason why China, which has benefitted so mightily from the flows of trade and investment that the system generates, should not become an insider too. The reform proposals recently announced by the communist party central committee suggest that at least in terms of domestic economic policy the leadership accepts the need for a fresh approach.

It is hard to exaggerate how much is at stake here. With Japanese and Chinese planes and naval craft circling around the disputed islands, a misjudgement by either side could set off a violent chain-reaction embroiling many other powers, Sarajevo 1914-style. On the other hand, economic tensions have already faded. Chinese tourists are thronging to Ginza department stores and Japanese autos are once more selling in China like steamed buns.

If the logic of economic benefit prevails, as it so disastrously failed to in 1914, there will be huge upside for both countries, the region and the entire world. If not, we are in for a very bumpy ride.

 

2 Responses to Shinzo Abe’s Challenge to China

  1. Been adding on yen for 20 years, but never read such a comprehensive an easily understood primer on japan. Anyone trying to understand Abe strategic plan needs to understand Takehashi and I’d like to see any work comparing the lessons Abe is taking from this legend. Any works u can recommend appreciated.

    • Thanks for your comments. There are two excellent books on the history – Lever of Empire by Mark Metzler and From Foot Soldier to Finance Minister by Richard Smethurst. Abenomics is too new for anyone to have written anything comprehensive yet.

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