East Asian geopolitics could affect China’s economy
China is currently facing an unprecedented geopolitical deadlock in East Asia as its bilateral relations with Japan, South Korea and North Korea each hit a nadir.
The rivalry between China and Japan is not expected to change in the near future given their different views on history as well as disputes over the Diaoyu Islands. Japan’s ambition to pursue “normalization” in recent years has inevitably transformed into moves in the Western Pacific region.
North Korea’s efforts to develop a nuclear arsenal and China’s sanctions on the country over the issue have chilled relations between the two neighbors and the situation may not change in the foreseeable future.
The major variable comes from South Korea, who has maintained close ties with China despite a longstanding strategic alliance with the US. South Korea clearly understands and accepts the need to balance relations with China and the US given its economic dependency on the former and security reliance on the latter. But the worsening North Korea nuclear issue and South Korea’s decision to deploy the Terminal High Altitude Area Defense ( THAAD) missile system from the US on the Korean Peninsula has triggered a watershed moment in relations between China and South Korea.
The biggest beneficiary from the geopolitical changes over the North Korea nuclear issue is the US. Some observers tend to assess the effectiveness of the US’ “rebalance” in Asia based on the South China
Sea issue and Trans- Pacific Partnership and conclude that the US has encountered setbacks. The cooling relations between the US and the Philippines seem to reinforce the perception. But we believe such a view is one- sided. The US’ strategy of rebalancing in Asia has reaped huge geopolitical gains, mainly setting East Asian countries against China. If the US deploys THAAD as it desires, it would be nothing short of building its military monitoring capacity on China’s doorstep.
The new geopolitical pattern in East Asia has just consolidated and China will certainly be affected. Further, the economic pressure will pose a number of practical problems for China amid its economic slowdown.
First, Japan and South Korea are irreplaceable economic and trade partners for China in Asia. The “double cold” trap – cold politics and cold economics – between China and Japan as well as China and South Korea would cause considerable loss to the country. Bilateral trade between China and Japan exceeded $ 300 billion in 2015 while between China and South Korea it reached $ 270 billion. China’s total trade with the two countries accounted for 14 percent of its foreign trade in 2015. Japan and South Korea’s geographical proximity as well as their close economic and trade ties with China render no other Asian countries a match in terms of economic significance.
It is worth noting that China’s trade and investment with Japan and South Korea is losing momentum. According to customs data, trade between China and Japan has declined since peaking at $ 342.8 billion in 2011, and dropped 11 percent year- on- year in 2015. Trade between China and South Korea fell 5 percent in the same year, the first decline since 2009. Realistically, these setbacks could spell long- term structural damage for China’s economy.
Second, there is still a great deal China can learn from Japan and South Korea in terms of industry and technology. Investment and technological
transfer from the two countries are still needed in China. Both Japan and South Korea are China’s high- level technological partners and highly complementary with China in trade and investment. The two are valuable business partners that can bring knowhow and expertise, and with whom China can work with and learn from as it moves up the global value chain. However, foreign direct investment ( FDI) from Japan fell 56 percent year- on- year in 2015 after hitting a historical high in 2012. Being political savvy, some Japanese firms have shown hesitancy about investing in China amid worsening ties over the disputed Diaoyu Islands. Meanwhile, FDI from South Korea has been in a state of flux in recent years. In 2015, Japan and South Korea only accounted for 6 percent of China’s total FDI.
Can China endure the pressure and impact from this geopolitical dilemma in East Asia? Certainly impacts from trade and investment go both ways and South Korea, with a smaller economy, may need the Chinese market more than China needs theirs. But if the cold politics persists, it will inevitably leads to cold economics. Cold economics would push businesses toward other alternatives and would cause structural changes in trade and investment. We estimate that if the situation of cold politics and economics lasts for another two years South Korean firms will be forced to seek opportunities in other markets.
China’s transitional economy is fragile, which means it is less resilient to economic swings. There is an urgent need for Chinese policymakers to closely watch the potential risks that arise from the new geopolitical pattern in East Asia.