Fears of being left behind by China and South Korea are fuelling visceral anger and xenophobia in Japan. But is the prognosis really so dire?

EARLIER THIS year, with the rumblings from China’s economic juggernaut growing louder by the day, Japan’s conservative media began sounding alarm bells. In a 24-page feature in March, the right-leaning Sapio magazine warned that China was about to “buy up Japan”, noting how Chinese conglomerates were gobbling up real estate and resources – and even eyeing up uninhabited islands around Japan’s coast. Another magazine ran a front-page story entitled: Your next boss could be Chinese.

That was just a prelude to the orgy of national soul-searching accompanying the summer news that China had overtaken Japan as the world’s number two economy in dollar terms – a position Japan had held for four decades.

Tokyo announced second-quarter figures in August, putting the value of its economy at roughly $1.28 trillion, just behind China’s $1.33 trillion.

The following month, Beijing leaned on Tokyo to release the captain of a fishing boat that had collided with a coastguard vessel in waters claimed by Japan. The timing of the maritime spat near the Senkaku (Japan) or Daiyou (China) islands confirmed fears that China’s expanding economic clout was increasingly matched by its political and military muscle.

All of which could be used to paint a very bleak picture indeed of one of the planet’s most important bilateral relationships – were it not for cold, economic facts. China gobbled up a record 19 per cent of Japan’s total exports last year, while Japan in turn bought 22 per cent of its imports from China, according to the Japan External Trade Organisation (Jetro).

Two decades of often bitter disputes over history, territory and politics have failed to knock the onward march of economic progress off course: China last year overtook the US to become Japan’s most important trading partner.

Long seen by Japanese companies as a source of cheap labour, China is increasingly now a market for finished products. For China, meanwhile, Japan is not only an important market but also a key source of advanced technology and investment.

“Japan is overwhelmingly the most important investor in China,” says Phil Deans, a China specialist at Temple University in Tokyo. Deans points out that even the impressive published statistics don’t do justice to the ties that now bind the two economies together. “About 40-50 per cent of all Taiwanese investment in China, for example, is directly linked to Japan,” he says.

Few serious analysts, therefore, expect the fallout from the Senkaku dispute to do lasting damage to the special – if strained – relationship between the two Asian giants, says Zhu Jianrong, a Chinese native and professor of international relations at Tokyo’s Toyo Gakuen University. “For China to continue along its path of development, it needs a peaceful environment and a good relationship with Japan. I can’t see anything changing that.”

Still, many Japanese feel the best is behind them as China steams ahead. Until the 1990s, Japan’s manufacturing prowess, powerhouse economy and hyper-modern cities inspired global envy. Some academics even predicted that Japan would overtake the US economy. But two lost decades have taken the swagger from the gait of this once confident giant. Stumbling corporations, spiralling national debt, and the prime ministerial merry-go-round now invite more scorn than envy.

Indications of Japan’s vertiginous decline are all around. Gross domestic product (GDP) per head fell from fourth in the world in 2001 to 22nd last year. Its share of global production has fallen below 10 per cent for the first time since 1982; its economy grew by a pallid 0.8 per cent in the decade up to 2009.

After years of government pump priming, public debt is approaching 200 per cent of GDP – the worst in the developed world. Blue-chip firms such as Sony and Hitachi have lost their lustre.

Yasuchika Hasegawa, president of Takeda Chemicals, summed up Japan’s sense of crisis this year when he said: “We need a new vision or we face the decline of our nation.”

This perception is heightened by the growing clout of not just China, but another neighbour, South Korea. Once considered Japan’s poorer country cousin, it briefly joined the world’s trillion-dollar economic club two years ago.

South Korean brands such as electronics giant Samsung and car-maker Hyundai are breathing down Japan’s neck. And unlike Japan, which still largely shuns inward investment, Seoul is powering ahead with plans to make the country more attractive to investors. “The Koreans are hungry like we were in the 1980s,” says Eddie Hughes, director of Enterprise Ireland’s Tokyo office. “It’s like a mirror of Ireland and the UK.”

The political impact of Japan’s growing despondency is difficult to predict. One ominous route for frustrations was on display after the freeing of the Chinese captain, which was greeted with fury by Japanese nationalists.

About 3,000 demonstrators gathered outside the Chinese Embassy in Tokyo to shout abuse. The Yukan Fujitabloid newspaper branded the release " dogeza gaiko" – appeasement diplomacy. Tokyo's right-wing governor Shintaro Ishihara called the Chinese "gangsters" and said last week it was time for Japan to seriously consider developing nuclear weapons. One Japanese former general even floated the possibility of war.

Together with nervousness about North Korea, the end result of the spat was to “increase Japanese insecurity on the one hand, and greater dependency on the US on the other,” according to Mark Selden, a veteran Japan-watcher based at Cornell University in the United States.

That twin-punch, and the ever-present tendency toward xenophobia in Japan, deals a serious blow to what was once seen as a potentially promising initiative of the centre-left Democrat (DPJ) government. Previous prime minister Yukio Hatoyama flirted with what he dubbed " yuai" – a fraternal relationship with old enemy China that could have brought both sides much closer: more political and cultural exchanges, an EU-style Asian market, even a military alliance.

With Hatoyama gone and both sides again in the political trenches, that initiative seems to be dead in the water. But there are other hopeful signs. Apart from those red-hot economic ties, there is the growing trickle of human traffic: about one million of the 6.7 million tourists who came to Japan last year were from China, according to the Japan National Tourism Organisation. With visa restrictions relaxed this year, that figure is sure to expand.

There are also opportunities for Japan to act as peace broker in the growing spat between the US and China over the value of the yuan. As a staunch ally of Washington and a leading trade partner with China, Japan is between two stools: under pressure from Washington to lean on Beijing to revalue the yuan, while perhaps better understanding Beijing’s position.

Tokyo, after all, was in a similar fix in the 1980s when it was widely accused of using its cheap yen to undercut American manufacturers. That a situation was resolved swiftly with the 1985 Plaza Accord, which quickly doubled the value of the yen against the dollar. Japanese manufacturers in China don’t want the yuan to appreciate too sharply, and Tokyo is a lot happier than Washington with its trade balance with China, which is almost par. Also, cheap Chinese goods are one major reason many Japanese haven’t felt the full impact of the country’s two-decade slump.

Some experts are urging Tokyo to be a broker in the currency dispute.

"Japan should stand between the United States and China, and tell Washington not to employ protectionist measures and China to revalue the yuan for its own interest," Masahiro Kawai, dean of the Asian Development Bank Institute in Tokyo told Kyodo Newsrecently.

Takeda Chemical’s Hasegawa is one of a growing number of Japanese executives, meanwhile, who say that despite the recent problems, Japan’s corporate world is undergoing a seismic shift away from reliance on its old markets in Europe and the US, and toward its near neighbours.

“Asia is outgrowing the rest of the world and is therefore becoming a more and more important trade partner for Japan,” he says.

There’s also a belief among some that China has overplayed its hand. Jeff Kingston, director of Asian Studies at Temple University in Tokyo, is of this mindset.

“Being bypassed by China is not much of an issue,” he says. “It’s more that Japan was forced to kowtow to China, and China rubbed it in. Many Japanese are viscerally angry that China is flexing its muscles and putting Japan in its place in such a public way.

“This has inflicted lasting scars. There’s a depth of anger that will linger for quite some time. The Japanese are now convinced that they cannot trust China. The only bright part of the economy was exports to China, and now people here feel they can’t rely on them. This will backfire on China. Japanese companies will be looking around for other places to invest. Vietnam, Indonesia and India will gain.”

To make the most of that shift, Hasegawa says Japanese companies must produce something akin to a revolution: restructuring for a world where English, or even Chinese, is the lingua franca, and where genuine co-operation with foreign boards and bosses is demanded. Only time will tell if the Japanese are willing to make that change.