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The tiny islands in the East China Sea, called Senkaku in Japanese and Diaoyu in Chinese. (AP)
The tiny islands in the East China Sea, called Senkaku in Japanese and Diaoyu in Chinese. (AP)

China, Japan could use a market shock to come to diplomatic senses Add to ...

They are tiny, uninhabited and seemingly insignificant territories. Yet the islets of the East China Sea have pushed Japan and China the closest to the brink of outright conflict since the Second World War ended.

Neither Tokyo nor Beijing has shown any signs of backing down on their claims to the Senkaku/Diaoyu islands. As Washington gets pulled ever more into taking sides in the dispute, the stakes are getting even higher for the situation to explode.

More Related to this Story

And yet, for investors on both sides of the sea, business goes on more or less as usual. In fact, from a financial market perspective, business is going very well indeed.

Despite heated concerns about a possible war breaking out with its giant neighbour, Japan’s benchmark Nikkei 225 index is actually booming, surging more than 45 per cent from a year ago. Meanwhile, Hong Kong’s Hang Seng index is up 8 per cent, while the Shanghai Shenzhen CSI 300 index is about 14 per cent higher and South Korea’s KOPSI index is up 3 per cent.

Clearly, geopolitics has had little impact on East Asian markets to date. But as Tokyo and Beijing remain at loggerheads over their status in the East Asian hierarchy, a market shock may be the quickest way for the two sides to come to their senses and see that they have far more in common, with burning issues to deal with, than they are currently prepared to admit.

Beyond the financial sector

Of course, Sino-Japanese tensions have already hurt the bottom line. In September, 2012, when Chinese protests against Japan’s claims to the islands were at their height, thousands of protesters demonstrated outside the Japanese embassy in Beijing.

Japanese manufacturers and businesses across China were hit hard by mass sabotage and looting, orchestrated in part by the Chinese government. Japanese airlines cut back on flights to China as the number of travellers to the country plunged.

Since China surpassed Japan to become the world’s second-largest economy in 2011, many believe Beijing can afford to antagonize Tokyo, now that it has the upper hand in the economic hierarchy. China has also surpassed the United States as Japan’s single biggest trading partner.

That logic, however, fails to stand up in the longer run. China may be the single biggest power in the Asia-Pacific, but its future success lies in a stable, prosperous region at large.

Two decades of putting the economy first

Two decades have passed since the World Bank released its report The East Asian Miracle, highlighting the success of the region in achieving phenomenal economic growth between 1965 and 1990. Granted, the growth trajectory has faced numerous challenges in the years since. But there is no doubt that the region has succeeded in spreading the wealth and bolstering living standards across the board.

Moreover, some of the attributes that have been singled out as traits for economic success – including high educational standards – remain unshaken. East Asian nations continue to dominate global education rankings.

Such success, however, has been based in part on the fact that East Asian nations have been united in putting their economic goals first. But as China, South Korea and Japan scramble to become the first among equals in the regional hierarchy, asserting national identity and airing historical grievances are pushing aside their obvious mutual interests of ensuring continued prosperity.

After all, the dispute over the East China Sea territories is not really about access to natural resources, but rather it represents a broader struggle over leadership in the region.

A dangerous game

That is a dangerous game to play, and may well jeopardize all the success that the region has achieved over the decades. Inability to reach a peaceful solution over the disputed territories, or at least allow the conflict to die down, runs the risk of capital flight. For now, market expectations are that diplomatic tensions will not affect trade.

Still, a plunge in share prices and a precipitous drop in trade may well be the wake-up call that Japan and China need to resume talks at the leadership level. Certainly, it would commit the powerful business sector on both sides to urge Japanese Prime Minister Shinzo Abe and Chinese Premier Xi Jinping to compromise in order to help the bottom line.

Bitterness toward past wrongs and seeking redemption for wounded national pride should not be defining diplomatic relations. The future of East Asia lies in building further on its economic success, not in territorial expansion.

Shihoko Goto is the program associate for Northeast Asia at the Woodrow Wilson International Center for Scholars in Washington, D.C. A version of this article was originally published by The Globalist. To follow on Twitter, visit @theglobalist.

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