The transformation in the political economy of China's economic relations with Japan in the era of reform

Abstract

Prior to the signing of the Long-Term Trade Agreement (LTTA) in 1978, management of China’s economic relations with Japan was centrally planned. The LTAA agreement, however, allowed the two countries to develop special bilateral economic relations, with China relying heavily on Japan for capital and technology to fuel its modernisation drive and Japan depending on China’s energy and raw materials to enhance its economic security. But China’s marketoriented reforms led to a transformation of economic relations between the two countries. Balanced bilateral trade became difficult to sustain as China’s oil production stagnated, and it became impossible to meet the huge demand for purchase of Japanese capital goods. As China reoriented its development strategy to adjust the balance between its different sectors, implementation of the LTTA agreement became harder to maintain. More generally, China’s global economic interdependence increased with internationalisation of the Chinese economy, contributing to Japan’s relative decline as a trading partner for China. Marketisation transformed the management of China–Japan economic relations, with decentralised economic interests becoming the driving force in the pattern of bilateral trade flows. From the mid-1980s, labour-intensive products replaced energy as China’s major exports to Japan. With the rapid development of Japanese foreign direct investment (FDI) in China, changes in bilateral trade patterns became closely associated with industrial restructuring in each country. This paper focuses on how China’s market-oriented reform and internationalisation led to changed economic relations with Japan. Reorientation of China’s development strategy was associated with acceptance of the notion of international economic interdependence; this contributed to the internationalisation of the Chinese economy but also to the erosion of Japan’s position as China’s predominant trading partner. Internationalisation also strengthened the division of labour in China based on the principle of comparative advantage and further shaped the pattern of bilateral trade between China and Japan. As China–Japan bilateral economic links expanded, adjustments to domestic interests in one country increasingly resulted in the need for adjustments in the other, at times contributing to bilateral economic friction, such as trade and FDI disputes. Dealing with these disputes tested management of the China–Japan economic relationship which became increasingly driven by decentralised market forces that made control via a centralised bilateral mechanism such as the LTTA agreement no longer feasible. The need to develop multilateral rules-based institutions to govern bilateral economic interchange became acute.