Shifting investments

Territorial disputes and a unilateral declaration of an Air Defense Identification Zone are just some of the reasons behind the months-long escalation of tensions between two of Asia's most powerful countries. But the mutual feelings of resentments have not only led to deterioration in political ties between China and Japan, they are also having an impact on bilateral investments.

For instance, Japanese foreign direct investment (FDI) into China declined by almost 50 percent in the first half of 2014 compared to the same period a year ago. Last year, Chinese direct investment into Japan fell by 23.5 percent in 2013, moving in the opposite direction to China's overall FDI abroad, which rose by 16.8 percent in 2013.

Rajiv Biswas, Asia-Pacific Chief Economist at the analytics firm IHS, says in a DW interview that as a result of the mounting tensions Japanese multinationals are refocusing their investments in Southeast Asia. ASEAN - the ten-member Association of South East Asian Nations - has a number of manufacturing hubs that have become increasingly attractive to Japan, particularly in comparison with China.

DW: What are the main political reasons behind the Japanese companies' shift away from China?

Rajiv Biswas: Japan's pivot to the ASEAN partly reflects push factors - factors that are "pushing" investment out of from a country - driving Japanese firms away from making new direct investments into China, notably the escalation of bilateral political tensions between Japan and China since 2012. Japanese firms operating in China have reacted to the anti-Japanese riots by reducing their foreign direct investment into China due to the increased risk to their China-based investments.

What are the economic advantages for Japanese companies to move away from China?

Japanese multinationals are facing not only rising anti-Japanese sentiment in China but also rapidly rising manufacturing labor costs in coastal Chinese provinces. This is contributing to the strategic shift of Japanese firms towards other low-cost manufacturing locations in Southeast Asia, such as Vietnam, Cambodia, Indonesia and Philippines, as well as other manufacturing hubs in emerging markets such as India, Brazil and Mexico.

How is this likely to impact the Chinese economy?

The impact of Japanese firms diverting their new direct investments away from China will not have a significant impact on overall Chinese growth, since total Japanese investment inflows are relatively small compared to the large size of Chinese Gross Domestic Product (GDP), which is already the world's second largest. However, it does have significant implications for the ASEAN economies, as the diversion of Japanese FDI from China towards ASEAN could have a large impact on total new direct investment flows into countries such as Indonesia, Philippines, Vietnam and Myanmar.

Why are Japanese multinationals focusing on the ASEAN member states, in particular?

The ASEAN domestic market is increasingly attractive for Japanese companies facing a mature consumer market and declining population in Japan. ASEAN has many "pull" factors - factors that are attracting or "pulling" investment into a country - and are attractive for Japanese multinationals.

With GDP in the ASEAN region having reached 2.4 trillion USD in 2014, a total population of 635 million people and a rapidly growing middle class, the region offers one of the fastest-growing market opportunities over the next two decades. Moreover, the bloc is achieving GDP growth of around six percent per year, thus creating a fast-growing market for Japanese companies across many sectors.

Which Japanese companies and industry sectors currently are investing the most in ASEAN?

There is surging interest in the ASEAN economies from Japanese firms across many manufacturing industries, including electronics, automotive, food products, power generation, construction equipment and industrial machinery, as well as companies in service industries such as banking and logistics. The large Japanese trading houses are also finding many opportunities in this dynamic landscape. This reflects the rapid growth in the size of middle classes in some of the most populous ASEAN economies, including Indonesia, Vietnam, Philippines and Myanmar.

Are there any political or economic risks involved in this investment shift?

For Japanese multinationals with complex manufacturing supply chains, the diversification of their manufacturing locations away from China should help to reduce vulnerability of their supply chains to political risk in China. However, direct investment decisions into ASEAN require in-depth analysis of the political and economic risks in each of the individual countries.

Singapore, for instance, is very low risk country due to its stable political environment and strong macroeconomic and financial system. However, the political and economic risks elsewhere in ASEAN can be significant, such as the recent political turmoil and military coup in Thailand shows.

How is Japan's new found enthusiasm for ASEAN perceived in the region?

Japanese firms have already invested heavily in establishing factories and offices in Southeast Asia for decades, so there has already been a significant Japanese corporate presence in many ASEAN countries. However, the latest surge of Japanese investment is creating a big boost to multilateral economic ties.

For most ASEAN countries, this new investment surge is most welcome, as it creates thousands of new local jobs and boosts economic growth. For example, in Myanmar three Japanese trading companies are investing in the development of a new industrial estate which could accelerate the development of Myanmar's manufacturing export sector. In Vietnam, Philippines and Myanmar, investment by Japanese banks in establishing local operations could play a significant role in strengthening their domestic banking sectors.

Rajiv Biswas is Asia-Pacific Chief Economist at IHS, a global information and analytics firm. He is responsible for coordination of economic analyses and forecasts for the Asia-Pacific region.