As the Sino-Japanese row over the Diaoyu Islands sours diplomatic relations between Beijing and Tokyo, the possibility that China will soon introduce trade sanctions against its East Asian rival is becoming more plausible with each new escalation in the territorial dispute.
Despite much discussion in the media, views remain largely mixed regarding the possible outcome of such a strategy. Some scholars believe that Chinese sanctions against Japan would lead to huge losses on both sides, while others think that China will be impacted much less than Japan.
For a clear picture of how economic countermeasures may affect both countries, we must take an objective look at the Sino-Japanese trade relationship in terms of several key aspects.
First of all, Japan's foreign trade portfolio has expanded greatly along with the rapid growth of the Chinese economy. Today, China is Japan's largest trade partner, export destination and source of imports. According to statistics from the Japan External Trade Organization (JETRO), the value of Sino-Japanese trade hit $344.9 billion last year, accounting for 20.6 percent of Japan's foreign trade but only 9 percent of China's during the same period.
Secondly, Japanese enterprises have made massive direct investments in China over the past decade. By the end of June, $83.97 billion in capital had flowed from Japan to China, while only $1.03 billion had moved in the opposite direction. If Japanese businesses pull the plug on their investments in China, as some are reportedly considering, they will not only miss out on the country's vital manufacturing network but also its lucrative sales market.
Thirdly, China held 18 trillion yen ($230 billion) worth of short-term and long-term Japanese government bonds as of the end of 2011, up 71 percent from a year earlier and making China the country's largest creditor, according to data from the Japanese Ministry of Finance and the Bank of Japan.
Japan's central bank recently announced that it would increase the size of its quantitative easing program, triggering heavy sell-offs of yen-denominated assets in the world financial market. Some have also speculated that China sold a portion of its holdings as a warning to Japan, although there is a possibility that such a move may have been just a reaction to the changing market climate rather than a prelude to future sanctions.
Fourthly, China is Japan's major supplier of rare earths and other strategic resources, which are used to make key components in many of the high-tech industries in which Japan is a world leader. With 23 percent of global reserves, China supplies more than 90 percent of the world's rare earths. While Japan has taken steps in recent years to reduce its dependence on rare earths from China, it still relies on the country for the majority of its rare earth imports.
Considering the above factors, if China really moves to impose economic sanctions on Japan, both economies will be severely affected, but there is no doubt that Japan will suffer greater economically.
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