2010-E-6
Japan and Management of the Transatlantic Crisis:International Responses and Domestic Struggles1
Takashi Terada* and Bernard Ong**
Graduate School of Asia-Pacific Studies, Waseda University
February 2011***
1

Professor, Organization for Asian Studies, Waseda University
Asia Fellow, Global Institute for Asian Regional Integration, Waseda University

A revised version will be published by Contemporary Politics.

Abstract
In addition to the perceived transformation of the international system brought about by the relative
materialistic decline of the U.S. hegemonic power, the crisis has also intensified ideational rivalry
and tensions between the U.S.-led capitalist model and the “Beijing Consensus”. This article aims to
examine how the structural transformations in both materialistic and ideational contexts, symbolised
by declining U.S. influence and growing Chinese voices, has influenced Japan, a key U.S. ally in theregion and China’s regional competitor. Based on a neo-classical realist framework which stresses
the need to analyse domestic political processes, this article sheds light on the influence of thesestructural transformations on Japan’s efforts to formulate its new growth strategies by rearranging
policy priorities and engaging in regional and international collaborations. Since the crisis took
place during a period which saw the demise of LDP’s five-decade rule and the advent of the DPJ
government, the article analyses to what extent the economic stimulus programmes (launched byboth old and new governments respectively) differed, and assesses how they have been effective interms of stimulating domestic demands. The article also highlights Japan’s efforts under the crisisled structural transformations to involve fast growing Asian economies in its new growth strategy
and to engage in the regional financial cooperation including the Chiang Mai Initiative
Multilateralisation.

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Introduction

The collapse of the U.S. banking sector in September 2008 has had an adverse impact on the global
financial system. Economies across the world experienced severe strains in their finance industries,
compelling many governments to nationalise their banks while putting in place stimulus packages toreinvigorate their domestic markets. As former U.S. Deputy Treasury Secretary Roger Altman (2009,1) argues, one of the most significant implications of this crisis is related to power shift: ‘thefinancial and economic crash of 2009, the worst in over 75 years, is a major geopolitical setback for
the U.S. and Europe’. While financial institutions in Asia are relatively unscathed from theeconomies which depended heavily on the American and European markets suffered from theconsequence of an overall decline in world demand and a pervading pessimistic business climate.
Japan was no exception, having (then) the second largest economy in the world which relied heavily
on both markets as its key export destinations. This article aims to examine how structuraltransformations in both materialistic and ideational contexts, symbolised by declining U.S. influenceand growing Chinese voices, have influenced Japan, a key U.S. ally in the region and China’s
regional competitor.

Based on the neo-classical realist framework which stresses the need to analyse domestic politicalprocesses alongside structural considerations, this article sheds light on the influence of thesestructural transformations on Japan’s efforts to formulate its new growth strategies by rearranging
policy priorities, and engaging in regional and international collaborations. This article firstly looks
at how the crisis has intensified the ideational rivalry and tensions between the U.S.-led capitalist
model and the Beijing Consensus and the perceived transformation of the international system inwhich the relative materialistic decline of the U.S. hegemonic power has been challenged by China.
It then gives an overview of Japan’s economic conditions and its key considerations in the current
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ongoing crisis, including the launch of a series of stimulus packages by the Democratic Party ofJapan (DPJ)-led government which has strove to manage the impact of the financial upheavals. Since
the crisis took place during a period which saw the demise of Liberal Democratic Party (LDP)’s fivedecade rule, this article examines the extent to which the economic stimulus programs, launched byboth the old and new governments respectively, were effective in terms of stimulating domestic
demands. Finally, the article explores Japan’s international endeavours to manage the problems
created by the financial crisis through cultivating new export markets in overcoming the tailspin in
demand from its tradition markets in the West. It highlights Japan’s efforts under the crisis-led
structural transformations to involve fast growing Asian economies in its new growth strategy and toengage in the regional financial cooperation including the Chiang Mai Initiative Multilateralisation
and an East Asian community idea.

Materialistic and ideational transformations of the international structure

The collapse of Lehman Brothers in September 2008 was seen as the trigger of the global financial
crisis. However, signs of an impending financial catastrophe were on the wall as early as in August
2007 when France’s largest bank, BNP Paribus suspended three of its funds linked to investments in
U.S. subprime mortgages. This was shortly followed by the failures of government-backed U.S.
financial giants such as Fannie Mae and Freddie Mac. The primary cause of the crisis was the U.S.
housing boom fueled by the availability of and ease of access to bank credits, resulting in massive
lending to aspiring home-owners with poor credit records, known as subprime borrowers. The
subprime loans, in turn, were securitized innovatively by the financial institutions in the form ofcollateralised debt obligations to attract more investors through the lure of higher returns. As interest
rates climbed, the number of home loan defaults and foreclosures also increased, bringing about aloss of investor confidence and injecting the chain effect of a contagious global financial crisis.
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Historically, developments of a worldwide consequence such as the 9.11 terrorists’ attacks have atendency to reshape the international political and economic landscape (Ong 2010). Economic crises,in particular, unsettle prevailing entrenched interests and regional arrangements, and provide
opportunities for new reformist coalitions to form (Jayasuriya 2008). While the ongoing crisis,
second only to the Great Depression of the 1930s, is a global phenomenon in nature, the economic
and reputational damage solely to the U.S. hegemonic power was unprecedented. The International
Monetary Fund (IMF) (2009, 30) in its Global Financial Stability Report attributed US$2.7 of the
US$4.1 trillion global losses in the current crisis to the U.S. banking sector alone. By the end of 2008,
U.S. banks had reportedly accumulated write-downs amounting to US$510 billion (New York Times
2009). At the micro-level, the crisis also forced U.S. financial institutions to severely curtail theirinvestments overseas. For example, the Bank of America was compelled to sell its stake in China
Construction Bank (CCB) in January 2008 and again in May 2009 to boost its own capitalization, amove which reduced its holding of the prominent Chinese bank from 30 to 11 percent (Xinhua
2009a). Likewise, Citigroup had to give up its holdings of Nikko, Japan’s top three securities groups,
less than three years after gaining a foothold in the Japanese market (Japan Times 2009a).

The material damage to the U.S. economy extended to the non-financial sectors. US multinational
companies, which were once considered prospective challengers to replace the traditional role of thestate, such as General Motors (GM), collapsed one after another like a deck of cards. In automobiles,
for example, the sales of new vehicles fell to a 25-year low in the U.S. in 2008. Total auto production
and domestic sales by GM, Chrysler and Ford, collectively known as the Detroit Three, registeredalmost a 25 percent decline in 2008 (DOC 2009, 59). The subprime crisis, coupled by rising fuelprice, led to a drastic fall in motor sales. The U.S. government eventually had to bail out GM andChrysler. The woes of the U.S. automobile industry hurt not just the automakers but also its upstream
4and downstream peripheries, including parts suppliers and car dealers. The magnitude of damages to
U.S. assets was so overwhelming that McKinsey & Company concludes in its analysis of the crisis
that the U.S. role in the world economy, its leadership of capitalism and democracy, and its ‘moral
authority’, had been severely weakened (Webb 2009). Others point to the ‘lack of basic crisis
leadership’ by the U.S. and the failure to take decisive action in dealing with the crisis (Fisher 2008,
6). The crisis’s ‘tsunami effect’ on the U.S. economy, coupled with the perceived poor handling of
the economic upheaval by the U.S. administration, marks the genesis of an increasingly disgruntledinternational community towards the U.S. capitalist model.

On the other hand, while the Chinese economy has not been spared from the impact of the crisis,
Beijing was in a far better position than the U.S. to ride out the crisis, and to emerge as an ever more
important global actor. In the finance sector, for example, the Chinese banks now dominate theranking of the world’s best banks by market capitalisation (Economist 2009), while the Chinese
stock market was forecasted to surpass that of the U.S. to become the world’s largest by value within
three years (Bloomberg 2009). Outside of the finance sector, 43 Chinese companies were listed in
Fortune’s world’s 500 largest companies, marking a sharp increase from only eight Chinesecompanies a decade ago (Xinhua 2009b). These figures indicate China’s growing economic
influence, as was shared by U.S. Treasury Secretary Timothy Geithner, who declared that ‘China is
playing a very important stabilizing role in the international financial system’ (Wall Street Journal2009).

Aside from the transformation in the international structure in terms of material capabilities between
the U.S. and China, the crisis has also brought to the fore the ideational rivalry between the‘Washington Consensus’ and ‘Beijing Consensus’. Despite Williamson’s (2008) claims on themisrepresentation of his original intent for the Washington Consensus, it has become to be viewed as5synonymous with neoliberalism and market fundamentalism. For Stiglitz (2008, 49), ‘the failures ofthe Washington Consensus became increasingly evident - especially after the crises, beginning with
the Mexican crisis and followed by the East Asian crises, the Russian crisis, and the Argentine crisis’.
Stiglitz’s criticisms of the Washington Consensus bear resemblance to the key tenet of the ideas
espoused by Ramo (2004, 5) on the Beijing Consensus which, he argues:
contains many ideas that are not about economics. They are about politics, quality of life, andthe global balance of power. Inherently, this model sets China and its followers off against
the development ideas and power needs of the status quo.
The Beijing Consensus sounded attractive for nations which strive not only to develop but to:
fit into the international order in a way that allows them to be truly independent, to protect
their way of life and political choices in a world with a single massively powerful centre ofgravity (Ramo 2004, 3).
In other words, the Chinese were seen as wanting to:control, localize and administer their own global future. This has instinctively set them up
against the kind of mail-order prescriptions of the Washington Consensus and distanced themfrom the whole history of first-world economic advice. Beijing is determined to find its own
route (Ramo 2004, 33).

The ongoing crisis could thus be seen as a vindication of the Beijing Consensus in many ways. For
example, the anti-thesis against state interference in the markets, as promoted by the Washington
Consensus school, has lost some footing in the wake of Obama Administration’s strong push to
overhaul the U.S. banking sector by placing its banks and financial markets under stricter
government supervision. In effect, the proposed banking bill empowered the U.S. government to‘constrain the activities of big banks, including forcing them to divest certain operations’ andexpands ‘the regulatory reach of Washington’s major agencies’ (Holzer 2010). On the other hand,6the pragmatic ideas of economic development espoused by the Beijing Consensus camp have won
more supporters after this crisis. Beijing’s quick and decisive injection of a four trillion-yuan
package in November 2008 was touted as a crucial state intervention which lifted China out of the
global economic doldrums in double time. The Economist (2010, 41) reports that the Chinese
development model has attracted many admirers from developing countries which now seek ‘to copy
‘the China model’’. This observation is echoed by Halper (2010, 134) who insists that a ‘growing
number of countries are starry-eyed about the new alternative development model – and its billboard
in Beijing’. In one of the strongest indication of the ideological shift, the crisis has intensified thepartnership between the four developing BRIC (Brazil, Russia, India and China) countries. At ameeting to discuss the global financial crisis in Russia in June 2009, the BRIC countries reportedly
advanced the possibility of dumping the U.S. dollar as the world’s reserve. This ideological swing
away from the Washington Consensus is encapsulated in Brazilian President Lula da Silva’s
pronouncement after the meeting that ‘a new global economic geography has been born’ (Asia Times
2010).

The crux of this ideological debate sparked by the global financial crisis on the part of Japan iswhether Japan supports the Chinese or Washington consensus and how the financial crisis affects thepolicy diagnosis preferences. Japan used to be at loggerheads with the U.S. over attempts to open up
its markets in the 1980s and 1990s, and was accused of promoting a developmental state model
which shared elements such as the governmental intervention in the markets with the BeijingConsensus. As will be discussed in more detail, there is a strong impulse to lean towards the Chinese
approach, with Prime Minister Yukio Hatoyama’s interest in working together with China in his
attempt to create an East Asian community an example of this turn to the East. However, China andJapan differ over political and economic values such as the promotion of democracy, human rights or7

intellectual property rights, and this fundamental difference will never allow Japan to fully join the
Beijing Consensus camp, leaving Japan in a delicate position in its relations with China.

Japan’s responses to the crisis: domestic measures

In Japan, the crisis has heightened policy-makers’ awareness to the transformation of theinternational structure caused by the rapid growth of the Chinese economy and its rising influence inthe global economic and political landscapes. While the international structure is the springboard forthis analysis, Japan’s foreign policy responses in the crisis can be explained more precisely throughthe examination of its domestic political situations by tracing the perceptions, ideas, or roles ofindividuals or organizations in domestic politics (Terada 2010). Christensen and Zakaria, forexample, highlight the ability of ‘perceptual ‘shocks’, in which single events suddenly make decision
makers aware of the cumulative effects of gradual long-term power trends’ (cited in Rose 1998, 160).
While recognizing that structure is an important independent variable, this article maintains that
foreign policy is contingent on the capacity of the state to mobilize resources and implement policychanges as ‘a domestic-level intervening variable’ (Rose 1998, 153). Neoclassical realism utilises
domestic politics ‘to explain why states do not heed the imperatives of the system’ (Rathbun 2008,298). Furthermore, a neoclassical realist approach to this discussion is appropriate given that thepresent crisis coincided with the cessation of the LDP’s rule of more than half a century and thesubsequent installation of a new coalition government led by the DPJ. In his analysis of the current
crisis, Chief Adviser to the China Banking Regulatory Commission, Andrew Sheng (2009, 409)
declares that ‘all financial crises are crisis of governance… All crisis have to be solved bygovernments, and if not satisfactorily, by the next government’.

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In Japan, the magnitude of U.S. banking failure had not been perceived so destructively during theearly stage of the crisis. In fact, Japanese financial institutions greeted the collapse of Lehman
Brothers and other U.S. institutions with a sense of optimism, and went on a spree to procure cheap
U.S. assets at fire-sale prices during the onset of the crisis. For instance, Mitsubishi UFJ Financial
Group acquired a 21 percent stake in Morgan Stanley while Nomura Holdings bought over the AsiaPacific and European operations of Lehman Brothers in a deal pronounced by Nomura President
Kenichi Watanabe as ‘a once-in-a-generation opportunity’ (Kyodo News 2008). On a global scale,Japan under the former LDP government, in the run-up to its own domestic election, also tried toassume a global leadership role by offering to steer the world economies out of the crisis. At theGroup of 20 (G20) Summit in November 2008, then Prime Minister Taro Aso explained that Japan’s
experience in coping with a banking crisis in the late 1990s put the country in good stead to play a
key role in addressing the global financial turmoil, and offered to provide up to US$100 billion to the
IMF as an interim stop-gap measure (Cabinet Secretariat, 2008a).

As was the cases of Germany and Mexico which heavily relied on the U.S. markets for exports, theJapanese economy was also hit by the tailspin in world demand for its products. In automobiles, forexample, the U.S. was a major market to the Japanese automakers, with Toyota and Honda selling
more vehicles in North America than in Japan (DOC, 22). A major reason for Japan’s exit from its
decade-long recession in the 1990s, for example, was attributed to its strong exports, which
accounted for approximately two-thirds of Japan’s real GDP growth since the early-2000s (Japan
Times 2009b). The falling demand for Japanese goods overseas due to the U.S. banking crisis began
to worsen the economic conditions in Japan. The 2009 White Paper on International Economy andTrade (METI 2009a, 316) shows that Japan suffered the biggest decline in exports among the majorcountries, recording a 39.1 percent fall in its exports growth on a year-to-year basis in 2009. While
Chinese exports also dropped by nearly 17 per cent year on year, Chinese companies primarily
9exported basic products such as general machineries and apparels to the U.S. Japan, on the other
hand, exported higher value-added products to the U.S. particularly in automobile and transportationequipment sectors which were more responsive to the negative effects of a global financial meltdown
helping to explain the relative severity of the decrease in Japan (METI 2009a, p.328-9). Adding to its
exports woes, the Japanese economy also lacked the injection of a strong FDI inflow. IMF estimatesthat the stock of FDI inflow to Japan’s GDP was less than one-tenth the average of other G7countries (Khatri 2008, 210). Symbolically, Japan’s status as the world second largest economy waslost against China by the second quarter of 2010 when the Japanese economy was valued at US$1.28
trillion compared to China’s US$1.33 trillion (New York Times 2010). While it remains unclear as to
how China’s ascendance to the world second largest economy was directly associated with Japan’s
decreasing exports to a less import-oriented U.S., this symbolic replacement was partly attributed toJapan’s futile struggle to recover from the decade-long depression.

To curtail the negative effects of the crisis on the economy, the Japanese government, under both the
LDP and DPJ administrations, launched a string of initiatives to stimulate the domestic markets.
Three months after assuming power and a year into the crisis, the DPJ government outlined its
ambitious economic targets to increase Japan’s nominal GDP growth by 1.4 times to 650 trillion yen,and to lower jobless rate to less than 3 percent by 2020 (Yomiuri Shimbun 2010). Nonetheless, ahuge deficit spending by the previous LDP administrations left the DPJ government with anunprecedented level of government debt. IMF data suggests that Japan’s net public debt amounted toover 85 percent of its GDP, which was one of the highest among OECD countries (Botman, et al.
2008, 47). The concern over Japan’s fiscal health was so severe that it led to a stern warning byStandard & Poor’s that Japan’s grading would be downgraded unless the country took more steps toreduce its fiscal debts (Financial Times 2010).

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In the meantime, in January 2010, the government launched a 7.2 trillion yen supplementary budget
containing another slew of stimulus measures to boost the economy. The DPJ government will
therefore face an uphill task to fulfill its election promises, which include the child-care allowance,
the abolishment of highway road tax, and not raising the consumption tax. Yet Japan collected
merely 9.5 percent of its tax revenue from consumption tax as compared to an average of 19.3
percent among OECD countries, and its overall tax ratio of about 26 percent is lower than mostdeveloped countries according to IMF estimates (Keen 2008, 64&69). Japan’s worsening fiscal
condition compelled the Kan government to consider reversing its election promise of not raising its
consumption tax for at least four years. In February 2010, Kan, then the finance minister, announced
that the government would accelerate discussion on tax revision. To fund these projects, the DPJ
government announced the issue of new bonds worth 44.3 trillion yen, the largest in history despite
DPJ’s previous criticisms of the excessive issuance of government bonds by the previous LDP
administrations. These domestic challenges, coupled by the scandal involving DPJ Secretary-General
Ichiro Ozawa’s illegal land purchases, caused the approval rating of the former Hatoyama
Administration to fall from 79 percent to 37 percent in February 2010 (Asahi Shimbun 2010a).
Hatoyama was eventually forced to relinquish his post to Kan in June 2010, which was due toHatoyama’s vacillating statements over the relocation of the U.S. bases in Okinawa as well as his
political fund scandal. However, shortly after taking over the premiership from Hatoyama andbeating Ozawa to become the new DPJ President in September 2010, the public approval rating forPrime Minister Kan and his cabinet plunged from 67 to 26 percent in November 2010 as aconsequence of both the deteriorating Japanese economy and the perceived poor handling of the
Sino-Japanese territorial dispute (Mainichi Shimbun 2010).

The DPJ government therefore found itself facing tremendous domestic political problems in thewake of current crisis, slightly over a year of coming into power. One way of offsetting the criticism
11was to divert public discontent over politics by putting the blame on the previous ruling party forcausing the current massive fiscal deficits. As former Prime Minister Hatoyama declared: ‘wesucceeded in identifying a large amount of waste that had been ignored under previous governments’(Cabinet Secretariat 2009a). In addition to quick implementation by the relevant ministries, public
popularity is a key to the smooth approval of proposed stimulus packages in the Diet as well, and oneof the approaches the DPJ took was the introduction of a review process where selected majorbudgetary requests had to be screened by the DPJ politicians and private sector practitioners in frontof a public audience. The review was expected to identity where taxes were wasted as a way of
reducing the fiscal spending, but the budgetary review did not impose any legally-binding
obligations on the ministries and relevant public corporations, leading to its effectiveness being
questioned. What has been important for the DPJ was that it soon turned to be a useful weapon to
gain the public support by putting direct pressure on the bureaucracy for curtailing the budget. The
review succeeded in appealing to the public that a number of public corporations, where ex-seniorbureaucrats were appointed as executives with extravagant salaries, wasted their taxes. Thanks to thereview, many in Japan came to know, for the first time, that some of the spacious offices with a small
number of working officials, mainly located at the central areas of Tokyo, were rented bygovernment corporations. This had never been practised under the LDP government, and it surely
attracted the public interest as the financial crisis led to a decrease in family incomes.

To help businesses deal with a rising yen, the DPJ-government under Kan’s leadership submitted a
supplementary budget to finance an additional 5.1 trillion yen stimulus package to the Japanese Diet
for approval. As profit margins of export-dependent companies are highly susceptible to swings inforeign exchange rates, the performance of Japanese companies most reliant on the U.S. and Europe
deteriorated during the crisis. Sony, for example, disclosed that the company lost 2 billion yen in
operating profits for every one yen increase against the U.S. dollar (Asahi Shimbun 2010b). Yoshito
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Sengoku, Chief Cabinet Secretary, explains that the ‘[new] measures are aimed at preventing anotherdip in the economy triggered by the decline of the economies in Europe and the United States’(Japan Times 2010). The new budget proposal came on the heels of several earlier approved stimulus
packages, which included the 15.4 trillion yen budget plan (under LDP’s Prime Minister Aso) in
April 2009, 7.2 trillion yen in December 2009 (under the Hatoyama government) and 0.9 trillion yen(first package offered under Kan) stimulus budgets in September 2010.

Despite the above measures, METI’s (2011a) monthly industrial production index in 2010 reflected apersistent gap of 10 percentage point below the pre-crisis level in 2007. On scrutiny, electronics,
manufacturing and transportation were the main sectors responsible for the fall in industrial
production. Furthermore, the national demand for steel, a key component in the construction andmanufacturing sectors, had also yet to recover to the pre-crisis level. Based on METI’s (2011b)
estimates, total steel demand in the 1st quarter of 2011 would register a modest increase of 0.2
percent from the previous quarter. However, the total crude steel production for the whole of 2010
maintained at about 90 percent of the pre-crisis level in 2007. The necessity for the series of stimulus
measures in a span of less than two years, couple with the sluggish economic data, suggest that thestimulus plans are both insufficient and ineffective yet to pull the Japan out of its economic doldrums.

Finally, one of the features in Japan’s stimulus package was environmentally-conscious, which major
developed nations tended to promote. For instance, the sales of energy-saving vehicles andecologically-friendly household products were encouraged by the government through tax
exemptions. They were also partly in response to Prime Minister Hatoyama’s ambitious
announcement at his first United Nations Summit on Climate Change in September 2009 on Japan’scommitment to a 25 percent reduction in greenhouse gas emissions from the level in 1990 by 2020
(Cabinet Secretariat 2009b). Other environmentally-friendly arrangements such as ‘eco-points’
13system, through which consumers would receive points for purchasing green electronics, and ecosubsidies to promote the household use of solar energy, stood in a sharp contrast to China’s stimulus
packages. The four trillion yuan of the Chinese package was mainly used for infrastructure
constructions including five new highways in Sichuan Province, which was hit by a huge earthquake
in May 2008, and nuclear power plant construction in Fujian Province, a coastal area where thenumber of bankruptcies was substantial due to the decline in exports. The conspicuous difference
between the focuses and areas which Japanese and Chinese stimulus packages promoted respectively,
illustrates the unlikelihood of Japan’s support for the Beijing Consensus approach even if the global
crisis has made it more acceptable to challenge the tenets of the Washington consensus.

Japan’s responses to the crisis: external measures

While pursuing fiscal policy measures at home, the DPJ government responded to the crisis bycultivating Asia as a new export market as a result of the collapse of the U.S. market. This
perspective is reflected in Prime Minister Hatoyama’s confession that ‘… while we will still consider
the alliance with the United States as important, we also want to create policy that places moreemphasis on Asia’ (Asahi Shimbun 2009a). Yet, Japan’s foreign policy in the wake of the global
crisis has been continuously constrained by its strong alliance with the U.S. For example, unlike
China, Japan has been extremely hesitant in reducing its holding of U.S. dollar-dominated foreign
reserves. Indeed, as Chinese holdings declined in 2009, Japan had in fact raised its holdings of U.S.
treasury bonds by US$11.5 billion to US$768.8 billion, regaining its position as the top foreign
holder of U.S. treasury securities, a spot which was lost to China in 2008. Explaining such a policy
stance, then-Japan’s Minister of Banking and Postal Services Shizuka Kamei revealed that ‘the U.S.
is having difficulty due to a lack of funds ... It is only natural that we should support the U.S. when it
is weak’ (Wall Street Journal 2010). Despite a growing concern among credit rating agencies on
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Japan’s fiscal health, Kamei went as far as to call on the Japan Post Bank to buy more U.S. treasuries
and corporate bonds (Financial Times 2010).

As mentioned earlier, to reduce the impact of the crisis, Japan intended to increase its exports toregions less affected by the crisis. The METI White Paper (METI 2009b, 14) explains that the Asian
economic zone and markets of emerging economies provide Japanese companies ‘great
opportunities’, given ‘Japanese-owned companies, under pressure due to the ongoing world
economic crisis, have come to have a growing awareness that their important task is to explore
markets of emerging economies and the Asian economic zone’ (METI 2009a, p.402).

In support of its Asia-centered strategy, Japanese finance and foreign affairs officials scaled up
Japan’s Official Development Assistance (ODA) contributions to Asia from 1.5 to 2 trillion yen
based on the new Asian Growth Initiative first unveiled by Prime Minister Taro Aso in 2009. Japan
had once abandoned an Asia-centered ODA provision approach to focus on cultivating other friendly
states, especially in Africa, which had been expected to support Japan’s international ambitions
including the permanent seat in UN Security Council. As a result, the major recipients of theenlarged-ODA budget came to include Indonesia, the Philippines, Vietnam and Mongolia.
Significantly, these ODA projects are geared towards the development of new infrastructure in therecipient countries with the aim to improve Japanese access to these new markets.

One of the Asian states which the DPJ government found crucial for both economic and political
Asia-centred strategies was India. Highlighting the potential of its market, Prime Minister Hatoyama
explained that Japan-India trade remains at one-twentieth to that of Japan-China’s, and further
stressed the need to conclude a Japan-India Economic Partnership Agreement (EPA) ‘at an early date’
when he met Indian Prime Minister Manmohan Singh during the Japan-India Summit Meeting in
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December 2009 (Cabinet Secretariat, 2009c). The Japan-India EPA was eventually concluded in
October 2010 between Prime Minister Kan and Prime Minister Singh. This agreement, the first FTA
under the DPJ government, was a means to boost Japanese exports to India and, more significantly,
to catch up with South Korea which had overtaken Japan in the FTA competition through signingagreements with the EU, India and the U.S. This motivation also drove Japan to make a decision toparticipate in the Trans-Pacific Partnership (TPP) agreement, a high-quality FTA with virtually all
products and all sectors to be included among all participating economies.

Japan’s participation in the TPP is politically very difficult as the current TPP members include big
agricultural exporters such as Australia, the U.S. and New Zealand. Japan has established FTAs with
ASEAN as an organisation and individual ASEAN member nations, but given its dominant trade andeconomic position it has an overwhelming advantage over partner countries such as Thailand or thePhilippines in terms of bargaining power. As a result, in the majority of cases Japan has been able toshelve considerations of the elimination of its agricultural tariffs and the FTAs have ultimatelyreflected Japan’s pre-eminence. This may represent ‘liberalization without political pain’ (Ravenhill
2003), but to persuade its potential FTA partners, Japan has in return utilized its economic power tooffer benefits in the form of economic cooperation. The use of this pattern has, up to the present,
enabled Japan to conclude FTAs that have avoided any promise of agricultural liberalisation. For thisvery reason, however, it is questionable whether Japan will be able to play an active role in the TPPor the Free Trade Agreement for the Asia-Pacific (FTAAP), first proposed by U.S. President Bush in2008. Within such multilateral FTAs, blocs are likely to be formed during negotiations between the
numerous exporting nations that share a common objective of gaining access to Japan’s agricultural
markets.

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The U.S. in particular presents a challenge, since Japan’s participation in the TPP would mean it
would establish a U.S.-Japan FTA. The DPJ government had initially included the conclusion of aU.S.-Japan FTA into its 2009 election manifesto, but the term ‘conclusion’ was eventuallyeliminated and replaced with ‘promotion’ as a result of increasing farmer protests against an FTA
with the world’s largest agricultural exporter. The DPJ needed the farmers’ votes, which proved to
be instrumental in securing a landslide victory for the DPJ in the 2009 Lower House election. Thus,
Japan’s eventual decision to join the TPP and the FTAAP would depend on whether political
momentum to promote agricultural liberalization can be gained by taking advantage of the direct
income compensation system for all farmers, a campaign promise made by the DPJ during that
Lower House election.

Proxy battle with China

China has now become a key consideration in Japan’s effort to seek new markets and cultivate Asia.
The share of Japanese total exports to China more than doubled from 6.3 percent in 2000 to 16
percent in 2008, so the Japanese business community is increasing looking at China ‘not only as amanufacturing base but also as a market’ (METI 2009a, 153). With the intention to kick-start
relations with the Chinese leadership on a cordial note, then-Prime Minister Hatoyama pledged not
to visit the Yasukuni Shrine when he assumed premiership. The Kan government has also avoided
visiting the shrine. The DPJ’s interest to develop greater economic linkages with China was not,however, bilaterally pursued, and it was approached partly through its engagement in the Northeast
Asian Trilateral Summit, together with South Korea. At the summit, Prime Minister Hatoyama called
for the three Northeast Asian countries to advance a trilateral FTA beginning with the conclusion ofa trilateral investment agreement in 2010. While the leaders of the three countries had annual
summits since 1999 on the sidelines of ASEAN+3 meetings, it was not until December 2008 in
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Fukuoka, Japan, when the summit meeting was formalized and held for the first time within
Northeast Asia. At the inaugural Northeast Asian Trilateral Summit in December 2008, then Prime
Minister Aso acknowledged that ‘it is rather unnatural that we have not had this sort of meeting
before … the financial crisis, I believe, encouraged or promoted this trilateral summit’ (Cabinet
Secretariat 2008b). Even prior to the Leaders’ Summit in 2008, the finance ministers of Japan, China
and Korea met for an informal trilateral meeting in November 2008, during which they agreed to anincrease the size of bilateral currency swap arrangements among the three countries (MOF 2008).
The three countries also took the first step to formalize the annual summit through the establishmentof a Trilateral Cooperation Cyber Secretariat (TCCS) in 2009, shortly after the crisis. Following theleaders’ summit, the three countries are also expected to begin a joint study on the feasibility of atrilateral FTA involving government officials, scholars and businessmen (Xinhua 2010). Revealing
the importance that the Northeast Asian countries place on the Trilateral Cooperation, the threeleaders met successfully for their Fourth Trilateral Summit in Hanoi in October 2010, on thesidelines of the ASEAN+3 meeting, despite the tense relations between China and Japan over the
Senkaku/Diaoyu Islands, thanks to South Korean President Lee’s intention to reconcile them. In
response to Chinese retaliatory measure to ban the export of rare resources to Japan during thebilateral spat, Prime Minister Kan skillfully used the opportunity of the trilateral summit to call forthe maintenance of a stable supply of earth minerals especially those required in the manufacturingof electronic products in Northeast Asia, according to Yonhap News (2010).

As METI’s White Paper declares: ‘while Asia presents the greatest opportunities for Japanesecompanies, it is also the region where ‘competition with South Korean and Chinese companies issevere’ (METI 2009b, 14). Japan saw an urgent need to check the influence of China while seeking
new resource-rich markets. For instance, after just two rounds of Japan-China policy dialogues on
the Mekong Region at the senior official level, Japan proceeded to propose the formalization of a18

Japan-Mekong Region (JMR) Summit in June 2009. The intense competition for regional influenceis evident from the composition of the JMR, which parallels the membership of the Greater Mekong
Sub-region (GMS) with the exception of China. Ruling out the establishment of a Japan-ChinaMekong Region framework, China explained that Beijing would prefer to focus on the existingarchitecture under GMS which was supported by the Asian Development Bank (ADB) (MOFA
2009a). Against the backdrop of the financial crisis, Japan hosted the inaugural Japan-Mekong
Region leaders’ Summit in November 2009. After the Summit, Prime Minister Hatoyama and his
counterparts from Cambodia, Laos, Myanmar, Thailand and Vietnam issued a joint declaration
announcing their intention to meet in Japan every three years and on the sidelines of the ASEAN
Summits in the other two years (MOFA 2009b). At the Summit, Japan also pledged more than 500
billion yen of ODA to the Mekong region in the next three years.

The global financial crisis also highlighted the growing impact, arising from the rise of China, interms of financial cooperation in East Asia. China emerged as a leader in regional financial
cooperation, a position that used to be predominantly occupied by Japan who played a prominentrole in the Asian financial crisis. Japan’s competition with China over the leading role in regional
financial cooperation can be seen as a proxy battle between China and the U.S. at the global level, as
far as the global financial crisis represents both the eroding U.S. international influence and thegrowing international role of China.

The battle between China and Japan over ‘which country pays more’ was also seen in the multilateralisation of Chiang Mai Initiative (CMI) in May 2009; again, the negotiations were prolonged
until both sides eventually agreed to provide equal contributions of 38.4 billion dollars for thesettlement, although the Chinese contribution included that of Hong Kong’s. In the end, the total
amount of 120 billion dollars was broken down with 32 percent by China and Japan each, 16 percent
19

by Korea and 20 percent by 10 ASEAN countries. Japan’s status as the largest contributor was again
matched by China, but in an international financial institution for the first time. One reason why thesize of the contributions is so contested between China and Japan is the tendency for nations to
consider their contributions as voting power in the new arrangements, culminating in the prolonged
negotiations. In fact, the distribution of contributions can be seen to reflect power in East Asianpolitics, as a senior MOF official confessed and Japan’s position that the amount of contribution byeach member in the multi-lateralisation of CMI should be proportionally allocated was consistent
with its national interest. The total loans Japan can provide in bilateral swap agreements within theexisting CMI exceeded US$40 billion, which more than doubled China’s total amount in the samearrangement (Asahi Shimbun 2009b). Therefore, Japan tended to stress the fact that it provided amuch larger contribution than China to international financial organisations such as IMF and ADB as
the second largest economy in the world; Japan’s quotas in IMF and ADB are 6.12 and 15.571
percent, respectively, while China’s current contributions are 3.72 and 6.429 percent. Yet, Japan did
not push its claim strongly because it thought the equal amount of contribution by both nations
would serve to put an end to the battle over ‘which country pays more’ which Japan would find it
difficult to win given China’s continued economic growth and the growing foreign exchange
reserves (Asahi Shimbun 2009b). This view indicated Japan’s hope that the equal contribution would
be perpetually kept in the regional financial architecture to maintain Japan’s influence. Eventually,
China, Japan, and ASEAN came to acquire voting shares of approximately 28 percent each, while
Korea was provided a 14 percent voting share, making it impossible for any single economy to havedecisive power in the CMI system.

Another case in point is the intense currency competition between the Chinese yuan and the Japaneseyen. Disclosing Japan’s intention to raise the profile of the Japanese yen in Asian trade, former Prime
Minister Aso (MOFA 2009c) mentioned: ‘to advance regional financial cooperation still further,
20

there is a need to promote the use of local currencies for intraregional trade and capital transactions’.
This remark was made largely in response to China’s expressed intention to internationalize the yuan.
In February 2009, a currency swap agreement between China and Malaysia was concluded underwhich China would provide up to 80 billion renminbi to Malaysia in the event of a financial crisis,and similar types of swap agreements were subsequently signed with Indonesia as well. This wasfollowed by another decision to allow the yuan to be used in overseas trade settlement in five
Chinese cities following a trial run with Hong Kong, Macau and ASEAN in December 2008 (China
Daily 2009a). China’s intent became more evident after announcing the renminbi-denominatedsettlement of trade between a limited number of Chinese cities such as Shanghai and some ASEAN
nations since 1 July 2009. According to the China Daily (2009b), after the first successful
completion of cross-border trade deals amounting to 14.38 million renminbi by three Shanghai
companies, business entities in Singapore, Indonesia and Malaysia have shown great interest to
switch to using the renminbi in their trade. Furthermore, in September 2009, China issued yuandominated two-year sovereign bonds to the amount of US$879 million in Hong Kong, for the firsttime, and a former PRC central bank official disclosed that the Chinese government could use Hong
Kong ‘as a trial ground before the Chinese yuan leapfrogs to the international markets as atransaction currency’ (China Daily 2010).

The Japanese MOF saw China’s arrangements in the renminbi as an attempt to increase the presenceof China’s currency in the payment of trades and investments in East Asia and responded to China’s
challenge by deciding to offer swap arrangements in yen (US$60 billion equivalent) with ASEAN
members in a form separate from CMI and to guarantee $5 billion in yen-denominated government
bonds (Samurai Bonds) issued by ASEAN members in the Japanese market. The Japan Bank forInternational Cooperation (JBIC) concluded an agreement with the Philippine government to provide
a guarantee totaling up to 100 billion yen for the latter’s issuance of Samurai bonds in February 2010.
21

The impetus behind Japan’s first kind of proposal to increase the utilisation of the yen in Asian
trades and investments was obvious even to an official from the Korean finance ministry who
observed that ‘Japan took a very aggressive move to curb the increase in the Chinese influence on
the Asian market’ (JoongAng Daily 2009). The China-Japan battle over the usage of their currencies
in East Asia became intense, but it also represents their common interest in creating a stable businessenvironment to avoid the risk of currency exchanges in the region.

However, it is well acknowledged that the exchange of the renminbi with other currencies is still
strictly controlled by the Chinese financial authority, so it is doubtful that foreign companies are
motivated to utilise the renminbi to settle their trade and investment transactions. Also, Japan’s planof emergency yen loans to countries falling into a foreign exchange shortage has a problem as well.
The fund is supposed to stem from Japan’s foreign reserves held in U.S. dollars, so selling such a
substantial amount of U.S. dollars in the currency market for conversion into yen would trigger yen
appreciation, providing trouble for Japanese exporting companies.

The Japan-China battle is instrumental in advancing the effectiveness of regional financial
cooperation. One of the examples is the creation of regional financial mechanism similar to the AsianMonetary Fund (AMF) proposal through the multi-lateralisation of the CMI, as was agreed upon in
May 2009. Through the multi-lateralisation of the CMI, for instance, the amount of funding could be
increased, and negotiations could be consolidated; thereby the CMI could serve as a regional lenderthat would be capable of responding with multi-lateral assistance in the event of financial crisis.

One serious problem in the CMI was the links with the IMF through the 20 percent conditionality
which made it difficult for East Asian countries to use CMI. This IMF conditionality means that only
20 percent of the total facilities of CMI can be utilised without linkages to the IMF programs.
22

Thailand, Indonesia, and Korea, all of whom had traumatic experiences in securing IMF-led rescue
packages during the 1997 Asian financial crisis which included hasty deregulation and privatization,
as represented by Washington Consensus, strongly wished to avoid using the CMI. In 2008, Korea
borrowed directly from the U.S. by extending the bilateral swap agreement (30 billion dollars) andincreased the amount of reserves in its arrangements with Japan and China to avoid relying on the
IMF and the CMI. Korn, the Thai Finance Minister, stated that there was a widespread perception in
East Asia that it was an act of suicide to rely on the IMF in light of domestic politics (Asahi Shimbun
2009c). Importantly, as the previous ASEAN+3 Finance Ministers had already indicated in February
2009, East Asian nations agreed that ‘after the surveillance mechanism becomes fully effective in its
function, the IMF de-linked portion may be increased from 20 percent’. The IMF conditionality was
introduced with a premise that ‘a financing arrangement that could lend too generously with too little
conditionality might create moral hazard for the government at the receiving end’ (Kawai & Houser
2007, 19). Yet, as Sussangkarn (2009), former Thai Finance Minister, declared, ‘it would indeed bedoubly hypocritical for those in the West or in the IMF to use this argument to try to block theestablishment of such an organization again’, given that concerns about the moral hazard problem
did not prevent American programs from bailing out large American financial institutions andautomobile companies.

The establishment of a new research office was announced at the ASEAN+3 finance ministers’
meeting in May 2009 in order to provide strong financial surveillance and monitoring systems,
which East Asia currently lacks. The establishment of those systems is a key initial step toward themulti-lateralisation of bilateral swap arrangements, which in turn is essential for the realization of the
AMF. A senior official in the Bank of Japan once acknowledged that the ASEAN secretariat was
unlikely to perform this function, but he added that the Regional Economic Monitoring Unit in the
ADB could do so, reflecting a view that Japan sees the ADB as its own institution and thus does not23

wish to see it replaced (Terada 2004). Yet, the ADB includes staff and funds from the U.S. andEuropean states in addition to ASEAN+3 members, so Western-oriented and more rule-based
governance thinking also prevails. In this case, if the ADB started suggesting the renminbi evaluation– a politically sensitive issue to China – as the IMF did, China would not support the ADB as asurveillance and monitoring institution, predicting another case of Japan-China competition in thebuilding of East Asian financial architectures. In this case, the decision to establish the ASEAN+3
Macroeconomic Research Office (AMRO) in May 2011 in Singapore to monitor regional financial
situations is a good way to settle the China-Japan battle over the politics of regional financial
mechanism and take a more cooperative step for the further institutionalization of East Asian
regionalism.

Conclusion

The unparallel rise of China both in terms of material and ideological capabilities has propelled
Japanese policy makers to inject greater fervency in their pursuit to retain the attractiveness of theJapanese economy. The evidence to date suggests that post-crisis Japan has sought to reduce its
reliance on its traditional markets in the West by exploring new export markets and establishingcloser partnership with the Asian region, especially in cultivating resource-rich countries in the
Mekong region and India. Japan’s new focus on Asia appears to have achieved some modest results.
Japanese exports in 2010 rose 22.4 percent, which marked the first increase in three years. Exports to
China alone accounted for more than 19 percent of its total shipment. (Mainichi Shimbun 2011).
While it might be too early to assess if these measures were sufficient to lift the country out of its
economic doldrums, they were in some ways perceived as necessary to retard the advances made by
China in light of the global crisis. What is clear is that the global crisis has reinforced Japaneseperceptions of the relative material and ideological powers of China vis-à-vis the U.S., urging Japan24

to take a couple of measures including more aggressive approach to the cultivation of Asian market
and regional financial architecture. Despite the uphill task ahead in overcoming the sluggish
economy, the crisis has also in some ways created opportunities for Japan given the fact thatJapanese big banks were relatively unscathed from the global crisis due to the modest scale of theirinternational operations, a basis for Japan to become a major financial hub to serve the rest of Asia,
as Toshiro Muto, former Finance Vice-Minister of Finance, declared (Yomiuri Shimbun 2009).

The global crisis has also provided an impetus for East Asia, in which almost 70 percent of trades aresettled in U.S. dollars, to consider the possibility of its own currency mechanism. Given that the total
GDP of ASEAN+3 nations is expected to surpass that of the U.S. and eventually that of the EU in
the near future, Masahiro Kawai, ADBI President, comments, ‘it's disturbing that the most vigorous
economic bloc in the world does not have its own currency system and relies on another currency’(Nihon Keizai Shimbun 2009). The crux of the argument rests on which currency East Asia will needto rely on within the regional financial architecture, yen or renminbi. The answer depends onwhether China will carry out the internationalisation of the renminbi by making it float on theinternational currency market, as this reform would decide the battle.

25

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GIARI Working Paper Vol. 2010-E-6,
February 2011
Published by Waseda University Global COE Program
Global Institute for Asian Regional Integration (GIARI),
Waseda University, Nishiwaseda Bldg. 5F#507 1-21-1
Nishi-waseda, Shinjuku-ku, Tokyo 169-0051 Japan
E-mail: affairs@waseda-giari.jp
Webpage: http://www.waseda-giari.jp
Printed in Japan by TRY-EX Inc.

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