Japan: The Sun Also Rises?

In the turbulent international coverage of economics and politics, stable and humdrum Japan does not have much of a presence. Yet, it is the world’s largest creditor nation while playing significant roles in trade, direct investment, and economic assistance.

Eclipsed over the past couple of decades by China’s rise, Japan nonetheless has reinforced itself as a leading geo-economic power while having almost thoroughly eliminated its huge non-performing loans in the banking sector and other structural vulnerabilities over the so-called “lost two decades” consequent on the bursting of its economic bubble in the early 1990s.

Emphasis on Japan’s world-largest public debt, which amounts to nearly 240 percent of its GDP, is misleading given that its public assets amount to nearly 200 percent and that government bond holdings by the Bank of Japan, in practice a part of the government, amount to more than 80 percent. This is consistent with the stability of a strong yen and very low long-term prime rates.

On the other hand, the US faces continuing and deepening structural vulnerabilities in stocks that resulted from the bankruptcy of Lehman Brothers in 2008 and the ensuing financial crisis, while experiencing a transitory boom in flows. The EU remains mired not only in serious structural vulnerabilities but also in a persistent recession.

Consequently, both the US and the EU have significantly less free hands in foreign economic policy, while keeping themselves busy to obtain or retain comparative gains through their strategic interaction, most notably in trade.

With quantitative tightening by the US Fed, the EU and, finally, the Japanese central banks, BRICS and other major developing economies are encountering increasing difficulties in financing for investment and growth, compounded by the shrinking of their US and European export outlets.

Particularly, the Chinese yuan is effectively pegged with the US dollar, while China’s money supply in yuan is in fact based on its dollar reserves. Consequently, China is sliding into a serious recession, aggravated by the intense trade war with the US. No wonder that, last October, China made an abrupt about-face on its persistent anti-Japan policy and concluded a currency swap agreement with Japan that is expected to furnish China with ¥3 trillion (US$296.3 billion) in the event of an acute liquidity crisis.

Looking closely at recent Japan-China interactions, Japan’s quiet rise is more conspicuous. For several years prior to official reconciliation between the two in October 2018, the two countries appeared to be competing head-to-head geo-economically, centering on aid and development via China’s “One Belt One Road Strategy” and Japan’s counter-strategy, or “Free and Open Indo-Pacific Strategy.”

China, however, is undergoing serious setbacks because many recipient/investee states have cancelled, cut down or postponed China-sponsored development projects. These states have fallen into China’s “debt trap,” and many of the projects have turned out to be financially, environmentally, and socially unsustainable. China is increasingly constrained to finance development projects due to the hardly discernible yet significant dwindling of its dollar reserves that is statistically covered up by its foreign borrowings.

Certainly, China has succeeded in luring more than 90 developing and developed countries with its huge fabricated foreign reserves as show money to participate in the China-led Asian Infrastructure Investment Bank. But the country has failed to secure the AIIB memberships of Japan and the United States, respectively the world’s largest creditor nation and the key currency nation with most developed financial and bond markets.

Without sufficient funds and staff, the AIIB cannot but co-finance projects with the World Bank and the Asian Development Bank to obtain a favorable credit rating necessary for financing through international financial markets.

In contrast, Japan has demanded that China observe international standards in aid and development, and agreed last October to selectively coordinate its policy with China only when Beijing meets these stringent conditions. There has been no major successful coordination case between the two to date.

Given that many of traditional Japanese aid recipients are no longer low-income countries, the Japanese approach will necessarily focus more on high quality aid and development in terms of sustainability through the public-private sector cooperation. The approach will be superior to China’s, at least over a medium to long run.

Additionally, Japan plays a leading role in preserving the existing free and open international economic system. Against the tide of populism and protectionism, most notably US President Donald Trump’s “America First” policy, Japan successfully led the formation of the Comprehensive and Progressive Agreement for Trans-Pacific Partnership after the US’s abrupt exit from an early TPP in the making, and concluded the Japan-EU Economic Partnership Agreement.

In nutshell, Japan’s geo-economic power and influence will be outstanding, at least for a mid-term. Yet, the country is not free from serious risks and problems. In the short term, Japan’s rise will remain quiet and, perhaps, unnoticed, especially because its geo-economic power and influence may be reduced by geo-political risks and crises, and because its vested bureaucratic interests hamper consolidation of its huge public debts and assets, which involves the great risk of a liquidity crisis.

For the long term, Japan also needs to find out a societal equation to cope with an unprecedented low birthrate and a high longevity rate. The world must stay tuned on humdrum Japan.

Masahiro Matsumura is Professor of International Politics and National Security, Faculty of Law of the St. Andrew's University in Osaka.