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China's Economic Brawn Unsettles Japanese
By JAMES BROOKE

TOKYO, June 26 - As politicians in Washington watch the Chinese bid for a big American oil and gas company play out, the reaction in Japan to the swelling economic muscle of China provides an early warning sign of the mixed emotions that China evokes as it rises on the global stage.

In the last five years, the Chinese economic boom overshadowed the political risks for the Japanese. But in May, export growth to China stalled. New polls of Japanese investors show a growing reluctance to make further investments in China.

The immediate catalyst for the changed attitude was a wave of anti-Japanese protests in Chinese cities in April. But those protests, tolerated by China's leaders, sent out a broader message: China would not object if its people, or its business executives, demonstrated their nationalism on the streets or in corporate boardrooms.

It was a stark reminder to investors and politicians around the world of China's willingness to play the nationalist card. And it amounted to a bucket of cold water for many Japanese investors who had assumed that they were secure in China because they were providing jobs and quality products.

The protests involving the two Asian powers had been fueled by deep disputes over World War II narratives in Japanese textbooks, territorial arguments and Prime Minister Junichiro Koizumi's visits to a shrine to Japanese war dead.

Robert A. Feldman, managing director of Morgan Stanley Japan, echoing fears that executives of Japanese companies rarely express publicly, said: "People are scared; they don't know where the Chinese are going with this." . The Japanese, Mr. Feldman said, "don't see a way out of the political mess," adding, "They are looking for alternatives."

In two surveys, separated by six months, the percentage of Japanese companies planning to expand operations in China dropped sharply, to just under 55 percent in late May, from 86 percent last December, according to the Japan External Trade Organization, the country's trade and investment promotion agency. The agency polled 414 Japanese companies operating in China last month, and a similar number late last year.

Although only 10 percent of the companies said that business had suffered from the protests, largely in reduced sales and tarnished brands, 36 percent said they were worried about future effects, and 45 percent said the business risk of operating in China had increased.

"The psychological impact the anti-Japan movement had on Japanese firms was far from small," Osamu Watanabe, chairman of the agency, said at a China-Japan investment conference in Beijing recently.

Reassuring Japanese investors will be crucial for China to invigorate the economy and create jobs in less prosperous areas that are inland from the booming coastline.

As China grows, Japan, the world's second-largest economy, will need powerful friends. In 2050, according to a new Goldman Sachs forecast, the Japanese economy will not be much larger than it is today, but China's is expected to be 30 times as large as now, or 6 times the size of Japan's. The forecast said that the world ranking of economies in 2050 would start with China, followed by the United States, then India.

For some Japanese investors, the anti-Japanese protests catalyzed sentiment to diversify away from China to Southeast Asia.

"It was a trigger," said Hiroyuki Maeda, executive vice president of the Uniden Corporation, a leading maker of cordless phones.

After a strike with nationalist overtones halted production for three days in mid-April at its plant in Shenzhen, officials of Uniden decided to accelerate a plan to open a factory in the Philippines this summer. In coming years, the Shenzhen payroll is planned to drop to 10,000, from 17,000 today, and China's share of Uniden's production to fall to about a third from 100 percent today.

The shift is prompted by a variety of reasons. Labor costs on the Chinese coast are no longer lower than in the Philippines. Uniden, which exports more than 80 percent of its phones to the United States, selling largely to Wal-Mart, Best Buy and Circuit City, is worried about calls in Congress to impose retaliatory tariffs on Chinese goods if Beijing does now allow an upward revaluation of its currency.

"Personally, I am much more worried about the U.S.-China relationship than the Japan-China relationship," Mr. Maeda said. "The case of a new tariff against Chinese imports is most scary for us."

In the United States, the unsolicited bid on Wednesday by the China National Offshore Oil Corporation, a state-controlled company, for Unocal raised new concerns about China's economic power as it continues its shift toward a market economy.

In Japan, though, some say that it is only the small fish who are nervous.

"Most big companies are not worried about this situation," said Hiroshi Kadota, China director for the Keidanren, Japan's powerful business association. Referring to the chilliness between the leaders of China and Japan, he added: "In the political sphere, there are many problems. But I don't think the economic relationship will be harmed."

Japanese carmakers have $5 billion invested in China, about 20 percent of the total invested by foreign automakers. Honda's joint-venture auto company in China announced Friday that it had started exporting cars made there to Europe, a first for a Japanese auto brand.

Other big companies, though, have begun to hedge their bets in China, balancing their investments there with others elsewhere in Asia. For example, Canon, the world's largest copier maker, is planning to spend about $45 million to build a factory in Vietnam.

"It is necessary for Japan to pursue a China-plus-one policy," Mr. Watanabe told reporters here on Thursday. "A company should invest not only in China but also one other place. I think the latest demonstrations gave a very good lesson to the companies as to the importance of a China-plus-one policy."

And to the Japanese, India represents an ever more fashionable business destination.
"Visa requests have gone up since political relations between Japan and China have worsened," Atul Razdan, spokesman for India's embassy here, said. "They are looking at India as an option. We welcome them."

Mixing business with geopolitics, Prime Minister Koizumi visited India late in April.

"Investment is increasing into India," Yoriko Kawaguchi, the prime minister's assistant for foreign affairs, said in an interview after meeting with Japanese business leaders in Shanghai. "Politically, as China grows more, we look to India more." With China now Japan's largest trading partner and destination for foreign investment, Chinese authorities are eager to reassure Japanese investors, Ms. Kawaguchi said.

"Chinese authorities are interested in keeping Japanese business in China," she said, adding that she did not think Japanese executives were stopping their investments in China.

Holding out the prospect of another olive branch, the Japanese are expected to ease travel policies soon, making China's entire population of 1.3 billion potentially eligible for Japan tourist visas. This would more than triple the size of the previous pool, which was restricted to several large cities and coastal provinces.

But from the Japanese side, the boom in cross-China Sea tourism has halted.

Japan Airlines is planning to increase flights to China by 5 percent. But after watching traffic on its China routes jump by 52 percent in the first quarter of this year, the carrier said that growth slowed in April to a 12.5 percent pace. In May, traffic fell 12 percent, as 15,000 Japanese tourists canceled their China trips.

"In the July-through-September period," said Geoffrey Tudor, Japan Airlines' international spokesman, "we think that tourism to China from Japan will be 50 percent below previous estimates.. People who may have been thinking about traveling to China are planning trips to other destinations."

Along with tourism, the growth in Japanese exports to China is slowing.

Last year, these exports recorded the sixth straight year of growth, jumping 29 percent, to $74 billion. But in the first five months of this year, exports were up only 5.9 percent, compared with the similar period last year. In April, exports of Japanese steel were down 18 percent, and exports of construction machinery down 47 percent. In May, exports over all fell, by 0.1 percent.

Some market watchers speculate that Chinese companies are holding back on making purchases overseas, gambling that the Beijing authorities will strengthen the currency, the yuan, later this summer.

A slowdown with China could spell an overall economic slowdown this year for Japan, whose economy is only expected to grow about 1.5 percent in 2005.

"We were once Asia's growth engine," Ms. Kawaguchi said, harking back to the 1970's and 80's. "Now it is China. One day it will be India."