Europeans are only slowly waking up to the emergence of economic powers over the horizon in Asia.

This is understandable given the enormous geographic, political and cultural distance between the two continents, compounded by the withdrawal of Europeans from their former colonies in the region. It also helps explain why the rise of China and India is only now being recognised as a bold challenge to the world’s existing economic and trade frameworks.

So how is all this being viewed by Japan, the one member of the club of advanced industrialised nations located in Asia?

Japan has been developing its own responses to the new global economic reality - only for it, the reality is neither new, nor purely economic.

For more than a decade and a half, Japan has been grappling with a much broader challenge, encompassing domestic politics, energy security, politico-military affairs, regional integration, currencies, the environment and human exchange. The country is enmeshed in a web of differing responses to many, separate challenges - each with its own characteristics and puzzling interactions.

Trade with China

The most talked-about challenge is the breathtaking expansion in China’s trade surplus. Its rapid export growth, and the concurrent rise in its appetite for resources to feed its export machine, have sparked fears of a looming global trade conflict that will pit China’s desire for rapid economic growth against its trading partners’ desire for balanced trade relations.

The recent Chinese take-off began from a low base after the Internet bubble burst in the second half of 2000 and following the post-9/11 slowdown. Nevertheless, annual increases in exports of more than 20% in every direction ? even for an economy the size of China's - are stunning.

Sources: Eurostat, U.S.-China Business Council, JETRO

These figures show that China’s entry into the World Trade Organization in 2003 affected the EU, US and Japan in a similar way. However, more recent statistics indicate that while the cycle of rapid growth in imports from China into Japan may have past its peak, it is still a politically sensitive issue for Europe and the US.

A look at exports to China shows how the paths being taken by the EU, the US and Japan are diverging still further.

Sources: Eurostat, U.S.-China Business Council, JETRO

In 2001, EU and US exports to China rose at much the same rate, while Japan lagged behind. However, this was followed by an explosive increase in Japan’s exports to China and a smaller, but still strong, rise in the US figures. The picture is far gloomier for the EU, as Chinese imports into the Union are rising at a far faster rate than EU exports to China.

The political implications of these figures for advanced economies are clear.Consumers in all three major economic regions are benefiting from stable or falling prices for many goods, as cheaper Chinese products replace more expensive domestic or imported goods. In the US and Japan, a healthy growth in exports to China has offset some of the previously corrosive impact on local manufacturing, with Japanese businessmen confirming that exports to China between 2002 and 2005 provided the demand which jump-started their country’s economic recovery.

Europe’s declining trade balance with China has little to do with the desirability of EU products. Rather, it results from the fact that Japan, China and the US have all managed their economies in ways which have ended up hurting Europe. The value of the euro and sterling have soared relative to the currencies of the Pacific trading nations, leading to Europe’s current high import/low export growth pattern.

Structural similarities

Many of the challenges facing Japan resemble those facing in Europe.

Japan is a country of 127 million people, one-tenth the size of China, one-eighth the size of India and one-third the size of ASEAN. Like Europe, its society is ageing rapidly, with more than 20% of the population now over the age of 65 and only about 20% under 20. For China, the comparable figures are 8% of the population over 65, 30% under 20; and for India, 5% over 65 and 40% under 20. This suggests that Japan is at a significant disadvantage both in terms of its potential consumer market and its potential pool of labour.

Of course, the mere size and shape of a country’s population does not tell the whole story about its economic potential. Japan has a low birth rate, but its people live long, healthy lives in relative wealth, with high levels of general education. This contrasts sharply with their counterparts in China and India, who face poverty, live shorter lives and have low levels of education.

Like Europe, Japan has relied on its technological prowess to compensate for a relative scarcity of resources. About 100,000 engineering students graduate from Japanese universities every year - twice the rate in the EU, which has 200,000 engineering graduates a year; and four times the rate in the US, with only 60,000. However, both China and India are producing even more, with 351,000 engineering degrees awarded annually in China and about 12,000 in India.

With the advent of the Internet, low-cost telecommunications and cooperative software, the world is entering an era in which engineering talent abounds: Japan will have to provide more than just good engineering in future.

Accepting an adjustment in stature

For the last century and a half, Japan has enjoyed an unusually dominant position within Asia.

A combination of geography and the policy of sakoku (closing the country to the outside world) meant that it avoided being swept up in the two great waves of European imperialism - the Portuguese-Spanish wave of the 16th and 17th centuries, and the Northern European wave of the 18th and 19th centuries. Indeed, Japan itself became an empire, attacking and subjugating its immediate neighbor Korea and occupying large areas of China.

China and India were the continent’s population giants and the home to some of the most world’s most ancient civilisations, but were nevertheless cast into colonial or semi-colonial status, with South-east Asia largely carved up between Great Britain, France and Holland.

Japan’s economic status in the region remained high even after the defeat of its formal empire in 1945, Indian independence in 1947, the founding of the People’s Republic of China in 1949, and independence for the south-east Asian countries. By integrating its economy into a global financial and trading system, and thanks to a conservative electoral democracy and an alliance with the US, Japan emerged from the ashes of World War II to become the world’s number two economic power.

Meanwhile, China embarked on a 30-year period of veering between collectivisation, dictatorship, revolutionary politics and military adventurism, and India staggered down a slow developmental path, balancing an open democracy with economic self-sufficiency and an aggressive approach toward the defence of its borders.

When Japan’s speculative bubble burst in 1989, this was widely seen as the trigger for the decline of its strength in Asia. However, it was but one of many revolutionary changes which redrew the economic map.

The fall of the Berlin Wall and the collapse of the Soviet Union in 1991 eliminated the raison d’etre of the Cold War security structure. The Tien An Men Square protests prompted the Chinese government to refocus its efforts on promoting an increase in incomes and boosting national unity by introducing a nationalist curriculum of “patriotic education”. In India, the rupee crisis of 1991 and the need to turn to the International Monetary Fund for help began the process of unshackling the energies of its entrepreneurial class from the strictures of the ‘License Raj’.

Meanwhile, the countries of South-east Asia continued to experience rapid growth, stimulated by investment by Japanese multinationals and soft yen loans. This prompted what was known as the ‘flying geese’ theory of regional development: Japan would provide technology, financing and consumer markets for the tiger economies while hiving off low-tech industries to the countries trailing in its wake.

This image persisted even after Japan’s economy slipped into stagnation and the South-east Asian version of the Japanese miracle came crashing down in 1997.

All of this is important to understand the Japanese approach today, because it explains its relative passivity in the face of the rise of the new Asian giants.

Japan recognises that trying to remain at the apex of the Asian economic order forever is futile and it is therefore unwise to see the inevitable rise of China and India to great politico-economic power status as a threat. Japan’s past record in China and Korea has also tarnished its image in the eyes of both countries’ governments, and reduced its chances of being seen as the region’s leader.

The greatest threats to Japan are not a few years of cheap Chinese goods flooding its market or ceding the production of some software to inexpensive India computer-code writers. It is the destabilisation of either of these two great powers.

Japan needs a strong China and a strong India. Japanese economic diplomats might push for more balanced trade or rational growth, but political considerations are sometimes more important.

Japan also recognises that competition, friendly or otherwise, is the new reality. For example, when it deploys the diplomatic weapons at its disposal - such as Official Development Assistance (ODA) - it must always expect and anticipate a Chinese countermove.

The rapid economic growth in India and China is creating enormous problems of environmental degradation and energy demand. However, Japan’s focus is on the effect that economic expansion is having on the military and security climate.

Chinese resentment over the humiliations of the 19th and 20th centuries persists. Chinese policy-makers believe that the Japan-US military alliance is preventing their country from fulfilling its historical destiny by uniting Taiwan with the mainland. There is a serious risk that such feelings may put China and Japan on a collision course, unless areas of conflict are carefully managed.

All this makes Japan wary about its growing economic integration with China. In stark contrast, it has warmly welcomed India’s rise.

The two countries joined forces to propose, with Germany and Brazil, expanding the permanent membership of the United Nations Security Council (although the initiative was blocked by China following an intensive lobbying effort in the developing world). Japan wants India to be included in an expanded ASEAN-led coordination of Asia’s trade and commerce and has insisted that India, Australia and New Zealand become members of the East Asian Summit (ASEM).

While Japan’s official relations with India are warm and those with China frosty, it is locked in a tightening economic embrace with the latter. Japanese Foreign Direct Investment (FDI) in China totalled $6.5 billion in 2005, pushing it to the top of national investment league ahead of South Korea and of the US.

According to China’s Ministry of Commerce, Japanese corporations are providing work for 9.2 million Chinese. Just one Japanese manufacturer, Matsushita Electric (Panasonic), has 70,000 Chinese employees, and nearly 115,000 Japanese now live in China, with 40,000 of them in Shanghai. There are now more than 510,000 Chinese legally resident in Japan, and the Justice Ministry estimates that another 30,000 are living in the country illegally (although the real figure is almost certainly much higher).

Complex economic and individual ties contrast with the lack of relations between the two governments. A freeze in bilateral summits between the leaders of the two countries (and between Japan and South Korea) prevents progress on pressing issues: China’s damaged environment; its appetite for raw materials and energy products; its extremely inefficient use of capital; the slow adjustment of its currency vis-a-vis the dollar; and the Communist Party’s promotion of an anti-Japanese school curriculum.

Future challenges

Of the two great emerging economies, India causes far fewer worries for Japan.

The Indian government does not base its management of the economy on trade: Indian goods and services are still largely produced for domestic consumption; the country’s exporters are private firms, not former arms of government ministries; and its English language-based business services sector complements, rather than competes with, the work of Japan’s multinationals.

Internally, land ownership by farmers and the rule of law help foster social stability in rural areas, while representative government remains the primary safety valve for relieving the pressures stemming from India’s economic transition.

As a result, the integration of India’s 1.1 billion population into the global economy is a relatively non-threatening development for Japan. The impact of China’s economic leap is less certain.

It has a surplus of all the means of production. It has 400 million people living in cities (only slightly less than the entire EU population). Many tens of millions of them are unemployed, an even larger number are underemployed, millions more are in line to lose their jobs in unreformed state-owned enterprises, and there are 900 million landless peasants in the Chinese countryside, providing a vast pool of potential workers.

The country also benefits from a huge influx of capital. Since it began reforming the economy in 1979, China has absorbed $600 billion in FDI. It also has a national savings rate of 46%. Taken together, these two factors provide China with a cushion of financial capital capable of sustaining an extraordinary fixed-asset investment ratio of more than 45% of GDP - a rate which promises that ever more productive capacity will come on line in the near future.

As for land, as one American economist commented, whatever else the Chinese Communist Party may be, it is certainly a very successful real estate developer. If an official sets his sights on constructing a factory, a road or a set of high-rise apartments, the bulldozers just come in and flatten whatever is there. The ability to secure land for an officially-approved project is essentially absolute.

When a country can take British economist David Ricardo’s three factors of production - labour, capital and land - and simply dismiss the threat of any of them becoming scarce, it is bound to have a large and unpredictable effect upon the world’s economy and politics.

There are huge social divides in China between its rural and urban populations, and between its coastal provinces and interior provinces. This, combined with its impact on international climate, its historical baggage, its large and ever-more sophisticated military forces and the absence of significant legal domestic channels of protest and conflict mediation, makes it impossible to ever be completely at ease with China’s economic rise.

In Japan, we strongly desire a peaceful rise for all of Asia. We also know that we must prepare for the possibility that we may not get what we want. The balance between all the factors at play - political, diplomatic, military, trade, commercial and personal - will remain a delicate one.

Japan will continue to keep its economy open to goods and services from the new economic powers, but the real moment of challenge will come if its security is threatened. The quest for a solid, regional entente to augment Japan’s military alliance with the US is indeed the precondition for stable economic interaction.