KGRI Working Papers
No.8

The China-Japan Cooperation and the Asian Century

Version1.0
September 2017

Masaya Sakuragawa1

Keio University Global Research Institute© Copyright 2017 Masaya Sakuragawa
Professor, Faculty of Economics, Keio University
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Email: masaya@econ.keio.ac.jp

The China-Japan Cooperation and the Asian Century 1

Masaya Sakuragawa

Abstract
If the gravity of the economic power shifts from West to Asia, but West keeps taking
leadership, the discrepancy between leadership and economic power will undermine theworld. The cooperation between China and Japan gives a hint to solve this mismatch.
This paper propose how China and Japan cooperates. It covers a lot of dimensions,
including leadership, Globalization, International rules, One Road and One Belt, theAIIB problem, Yen and Yuan internationalization, and the Asian monetary integration.

Asia as a World Leader
The world economy’s center of gravity is shifting from West to East. Without amajor distraction, Asia is likely to produce half of the world GDP by 2050. Asia isdestined to be the center of international trade, investment and finance. The question is
if Asia is prepared to lead everything, economically, politically, militarily, andtechnologically. It is going to be difficult without strong foundations of technologicaladvancement, innovation, and institutional quality.
United States and West are going to lead the world in terms of politics, security,
economy, and technology. They play a dominant role in the international system based

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This paper is written as the final chapter in the book entitled, “China and Japan in the Global
Economy”.

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on the multilateral arrangement: a UN system for political order, WTO and othermechanism for economic and trade order, and World Bank, IMF for the financial order.
However, the Donald Trump’s election has done substantial damage to American-West
soft power, which is based on the value system of freedom, human rights, anddemocracy.
If the gravity of the economic power shifts from West to Asia, but West keeps
taking the leadership, the discrepancy between leadership and economic power will
undermine the world. A town prospers when the rich become the bank and police.
The cooperation between China and Japan gives a hint to solve this mismatch.
However, one may be afraid of the China-Japan cooperation. Indeed, China and Japan
competes for the regional leadership. While Japan had been a political and economic
power in Asia, China has been catching up with Japan. Some degree of trust has to berestored for both to cooperate effectively. There are political, military, and historicaldisputes in the nation level. Due to the vicious spiral of medias and politics, public
opinion polls say that about 80 percent of Japanese do not trust China and about percent
of Chinese do not trust Japan. On the other hand, there is an increasing interdependence
at the citizen levels. Past 30 years, China and Japan have been closely integrated
through bilateral trade and capital flows. Increasing numbers of travellers visit Japan.
Additionally, increasing numbers of undergraduate and graduate students from China
seek jobs in Japanese big companies, and hope to live in Tokyo, the most beautiful andfantastic city in Asia.

Leadership

2There will be two constraints for the Asian leadership, the one for China and theother for Japan. Japan has been autarkic until the openness forced by the West in the
mid of the 19th century. Since the revolution called Meiji Restoration, Japan ascended
and attempted to take the hegemon in Asia. However, since the defeat of the WW2,
Japan is militarily subject to the US by the US-Japan military alliance, which would
work as constraints on the prosperity and stability of the future Asia. If Japan’s decision
making is controlled or manipulated by the United States, and if United States can force
Japan to make a decision that is against the interest of Japan, other Asian countries do
not believe that Japan is a leader. Japan has to become a “normal country”, whichmeans that all the decisions are to be made on the interest of its own country. This does
not mean that Japan should have nuclear weapons, but means that Japan has to decide if
Japan has nuclear weapons.
Historically, China has not been globalized except for the old Tang Dynasty. Since
the defeat of the Opium War, China was semi-colonized by West and invaded by Japan.
China is insular and xenophobic. The style and rationale of China’s ascendance to theinternational and regional order are not compatible with the 21th value system of
freedom, human rights, and democracy. In 2013, China’s President Xi Jinping unveiled
China’s new national strategy collectively known as One Belt One Road, a key part ofthe country’s “going-out” strategy. China seeks to force the core-periphery relation toneighbouring countries. ASEAN are afraid of the China’s outward policy against
multilateral diplomacy and core interests for territorial claims and sovereignty.
The historical fact that both China and Japan have had poor experiences of having equal
partnership internationally has been the obstacle to their leadership. However, theemergence of the Trump presidency will be a turning point for the establishment of the3

Asian leadership. His protectionism and military expressions that are lack ofconsistency are the force to have a common interest for China and Japan. The rejection
to TPP by the president Trump is against China and Japan who have a common interestin trade globalization. The US’s weakening military power in Asia will promote Asia to
be independent of the US and help the leadership of China and Japan in Asia.

Asia as a Winner of Globalization
Over the past three decades, the progress of financial globalization has beenaccompanied by the convergence in per-capita income between the Advanced and theEmerging. Capital inflows from the capital-rich Advanced to the capital-poor Emerging
supposedly contributed to convergence, but the reality is different. Capital has flown
from the Emerging to the Advanced since the late 1990s. What contributed to thissurprising pattern between growth and capital flows is Asia. Several Asian countries
realized export-oriented economic growth and ran current accounts. Asia is the winnerof globalization. In contrast, the West is a loser of globalization. Many westerncountries were defeated by the trade war with Asia, and imported the unemployment.
Populism prevailed in Western Europe or the entire Europe which means the entire
European continent will be politically more conservative, economically maybe lean
towards protectionism, and social culturally will be more chauvinism and in terms ofdecision-making, policy-making may become more fragmented.
Both China and Japan achieved their economic miracles by adopting exportoriented strategy. These two countries have benefited considerably from theunprecedented trade liberalization and globalization. With the Trump administration,
the progress of trade liberalization and globalization is highly likely to be interrupted, or4

even reversed. The two countries are in a good position to work together and jointly
take the leadership to promote regional economic integration and defend the global
trading system. Both countries and the whole Asia pacific region will benefit from theclose cooperation of the two countries.
With the demise of the Trans-Pacific-Partnership (TPP) negotiations, which included
Japan, Malaysia, Brunei, Singapore, and Vietnam, it is all the more necessary for the
RCEP members to conclude the negotiations. The RCEP agreement not only coalesces
FTA partners but also replaces nine economic partnership agreements and theASEAN+1 FTAs into a single agreement, between the negotiating countries. In
establishing the RCEP, it would facilitate and accelerate the development of regional
supply chains and boost the flow of trade and investment

International Rule
The establishment of Asian Infrastructure Investment Bank (AIIB) in December
2015 and the One Belt One Road (OBOR) were the epoch-making progress of theChinese international commitment. China now intends to provide an organization or aconceptual framework for infrastructure development in the world. Although the US
and Japan have some resistance in accepting the new initiatives, less developed
countries (LDCs), potential recipients of the financial support, basically welcomed
China’s new initiatives.
Two principals have steadily advanced in the context of the World Trade
Organization (WTO), free trade agreements (FTAs), and bilateral investment treaties(BITs). One is the liberalization principle, and the other is a backup for liberalization tolevel a playing field. The former prohibits any country from discriminating foreign5

countries in trade in goods and services, investment, and government procurements. The
latter includes the concept of the fair competition, including discipline or remedies for
subsidies, and the treatment of SOEs and other government’s involvement.
Although TPP was not agreed, it includes a path-breaking chapter on theinternational rules for implementing high-quality infrastructure investment. If privatecompanies and SOEs compete in bidding for a foreign infrastructure project, a SOE
subsidized by the government may win the bidding although this SOE does not have
any highest-quality project if there were no international rules. The competitiveenvironment to realize the high-quality projects is necessary for the development of the
global value chain in Asia.

One Belt One Road
In 2013, China’s President Xi Jinping unveiled China’s new national strategy
collectively known as One Belt One Road(OBOR), a key part of the country’s “goingout” strategy. OBOR is a development strategy that builds the network of highways,
railroads, and ports between China and other Eurasian countries. It is reminiscent of the
Marshall Plan, an American initiative to help rebuild Western European economies after
the end of World War II. The goals of that plan were to rebuild war-devastated regions,remove trade barriers, modernize industry, make Europe prosperous once more, andprevent the spread of communism.
China has to make others trust the goals of this plan. The success of OBOR relies
on if China builds the complementarity in economic relation with neighboring
economies. One may be afraid if OBOR is the tool of the demand creation for theovercapacity of the steel production. Or one may be afraid if OBOR is the means of6

establishing the China’s hegemon by colonizing neighboring Eurasian countries
economically.

Cooperative competition between ADB and AIIB
Since the establishment in 19xx, the Asian Development Bank (ADB), which Japanand the U.S. are leading shareholders, has had a significant role in developing,
researching, and financing integration initiatives. The establishment of AsianInfrastructure Investment Bank (AIIB) is a challenge to call for the change in theinternational order in the field of Asian development finance.
The concern is whether ADB and AIIB compete or cooperate. The essential pointlies ultimately in the trust between China and Japan. Unfortunately, currently there is
the lack of trust between Prime Minister Abe and President Xi Jinping. Japan sees thelack of transparency in the governance because China has a strong power of decision
making at AIIB, and anybody joining the AIIB has to have trust with the Chinese
decision maker, who may include President Xi Jinping.
In reality, ADB could not catch up with an increasing demand for infrastructure
investment in Asia. The establishment of AIIB emerged as a reaction to that criticism.
ADB applied the strict loan standards to developing countries , and is blamed for this“under-investment”. In contrast, AIIB is supposed to supply loans with far looser
standards than ADB, and raises the concern about the potential “over-investment” tolow-quality projects.
In principle, the organization that supplies the international public goods is best to bea monopoly so long as its organization is efficient. Otherwise, there is the room forcompetition although there is the inefficiency of the wasteful resources related to the7duplicative investments. Indeed, ADB and AIIB could complement with each other bypooling the fund together to support infrastructure projects which needs large inputs,
and share the risk of investment. On the other hand, the cooperation of far different
organizations in terms of international rules and conditionality could give rise to hugeorganizational inefficiencies. Particularly, if there are no international rules to discipline
subsisted SOEs who would bid for an infrastructure project, inefficient and wasteful
infrastructure will be built at the large scale in Asia.
We have to discuss the ADB versus AIIB problem in terms of how to realize theefficient stock of infrastructure in Asia. A “cooperative competition” is a keyword tosolve the problem. Both institutions can benefit from competition because they are
disciplined to use more flexible and innovative rules to find good projects. In particular,
via competition, AIIB certainly need to be more open for their governance structure. As
a result of competition, AIIB could grow up to benefit from the good track record of
ADB in project management and knowledge. The competition is an input for the
successful cooperation, which welcomes the international development part of the
China-Japan collaboration.

Triangle among China, Japan, and ASEAN
China and Japan have played a foundational role in institutional development andfacilitating regional integration, but the rationale and style behind China and Japan
strengthening ties differ. These differences may have significant implications for
ASEAN going forward. While Japan’s approach towards ASEAN and regional
integration shifted from bilateral basis to multilateral engagement, China rationale forbolstering its involvement in ASEAN’s regional integration agenda differs significantly.
8However, the Sino-Japan rivalry instead of having a detrimental effect on theregion and integration actually benefitted ASEAN by spurring institutional development
and mechanisms to facilitate regional integration. The Sino- Japan rivalry benefited thedevelopment of the Chiang Mai Initiative Multilateralisation (CMIM). In setting up the
new CMIM, the members agreed that 80 per cent of the funds would come from China,
Japan, and South Korea, with the other 20 per cent coming from ASEAN.
In order to strengthen Japan and ADB’s support for the initiatives, Japanese Prime
Minister Shinzo Abe in 2015 announced that Japan and the ADB would be providing
U.S.$110 billion in infrastructure funding over the next five years. This is part ofJapan’s new development program, seen as a direct response to China’s established
AIIB. In 2016, the AIIB has begun signing framework agreements and memorandumsof understanding with both the World Bank and ADB, respectively. The presidents of
the AIIB and ADB signed a cooperation memorandum on strengthening cooperation ininternational development.
ASEAN takes the casting vote. ASEAN is so diversified, so different in all kindsof issues and second, ASEAN has no leadership. One might wonder if ASEAN is
divided over issues such as the South China Sea. ASEAN is one of most growing areasin the next three decades, and need cooperation among member countries in order tobehave as a glue to draw the cooperation from Japan and China, which will in turnfacilitate regional integration and the Asian century.

The Yen and the Yuan:
Since the link to the gold was abolished in 1971, the credibility of the US dollars is
declining, giving rise to several epoch-making events, the Plaza agreement, the9emergence of the common currency euro, and Global imbalances. China and Japan haveemerged as the world’s largest creditors, while the US is the world’s largest debtor interms of net foreign assets. Nevertheless, the US Dollar (USD) has maintained its
dominant role as the world’s reserve currency. After the eruption of the financial crisis
triggered by the Lehman shock, the US dollar was rather strengthened, showing that the
US dollar looks really truly global currency and it is backed by the sound private capital
markets.
In contrast, the two major Asian currencies, the Japanese Yen (JPY) and theChinese Yuan (CHY), play a marginal role in the world economy. When China andJapan trade goods, the Chinese Yuan is first converted into the US dollar, and then the
US dollar is converted into the Japanese Yen. This would be a perverted world from thelens of the world under the gold standard. If the gold standard were to be adopted, JPY
and CHY are the two major international currencies because the valuation of currency isthen backed by the country’s gold reserves, which in turn is proportional to the net
foreign assets.
Japan once attempted to make an independent move from the US. Japan proposed
the creation of an Asian Monetary fund (AMF) during the 1997 Asian financial crisis at
the G7-IMF meetings. It was aimed towards securing a regional network funded by
Asian currencies, particularly by JPY to overcome the current crisis. This proposal of
the AMF stirred conflict between Japanese authorities and the United States, andrejected. Part of the proposal of the AMF was succeeded to the Chiang Mai Initiative(CMI). It was agreed by ministers of finance of several Asian countries to expand the
network of bilateral swap arrangement of foreign reserves against possible financial
crises.
10However, the attempt to push JPY up to the international currency was suspended
along with the long-lasting stagnation of the Japanese economy. In 1990, the Tokyo
market measured by the total amounts of stocks and private bonds dominated the New
Your or London market. Although financial markets were freely liberalized by 2000, themonetary policy set the nominal interest rate almost zero for the two decades, which inturn prevented the development of the Tokyo financial center.
China attempts to promote the internationalization of CHY by increasing the CHY
dominated transactions with the trading partners of ASEAN. Joining the member
country of SDR in 2015 is also a first step of pushing up CHY to the international
currency. Capital controls and other regulations on financial markets are the obstacle topushing up CHY to the global currency. In principal, for an economy like China, which
every year trades about $4 trillion in goods and services with the rest of the world andhas a liberalized current account, it is almost impossible to maintain a very rigid
managed floating system. The persistent depreciation of the yuan and massive capitaloutflows since 2016 challenges the stability of the Chinese economy and may trigger
financial crisis. This is the sign of a yellow lamp for the international currency.
What is common to Japan and China is that domestic financial markets are notmatured as to push their domestic currencies up to the global currency. For the USD, it
is obvious that the matured financial market serves as the collateral for the global key
currency. Among the all the international settlement, financial transactions amount tonearly 97 percent, while those of trade is only 3 percent. As episodes of the Wall street
and the Cities show, the internationalization of the domestic currency requests the
supply of financial assets denominated by the home currency to foreign investors.

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The central concern is how to develop the Asian financial markets, which willrealize risk sharing, liquidity provision, and an efficient capital allocation in this region.
The precondition for the developed financial infrastructure is to establish a settlement
system that is useful for Asian currencies.
Related are other aspects than the financial development. The financial architecture
should also be linked to growing energy demand in the region. Just as the commodity
futures exchanges have grown explosively after the oil crisis in 1970s, when the US was
the biggest crude oil importer, Japan is the largest natural gas importer today, andshould establish a LNG price index in the JPY, as the WTI is indexed in the USD. Only
then, the futures market will grow and the index will be used not only for buyer/seller
settlement, but also for hedging against the JPY.
The use of the domestic currency in Asia is closely related to the pattern of tradetransactions. To facilitate the further use of the yen in Asia, Japan needs to increase its
imports from Asian countries. Indeed, Japan has expanded its imports of manufacturing
goods from Asian countries. But, if most of imported intermediate inputs are used forfinal goods production destined for the US market, the USD tends to be chosen in Asia.
Similarly, although Chinese government attempts to promote the CHYinternationalization, the further use of CHY would not be expected unless China
increased its role of final destination market for neighboring Asian countries.

Asian monetary integration
The early experience in Europe, called the Werner Plan comprising three steps toachieve the European monetary integration, is useful to understand the procedure of themonetary integration. In the first stage, member countries are to be engaged in
12narrowing the fluctuation band of their exchange rates to the target. The anchor of thetarget is the new currency unit, which should be a basket currency. In the second stage,
they are to establish the regional monetary fund to supply liquidity. In the final stage,
this fund is to turn into the central bank.
Establishing the multicurrency clearing system in Asia (MCSA) contributes to thefirst stage. In principle, the clearing arrangement across multiple currencies eliminates
settlement risks for securities and currencies, and clears each currency on the paymentversus-payment basis, and facilities financial transactions among Asian countries.
Additionally, MCSA collects the data for financial transactions, and contributes tocalculating the accurate ratio of the currency basket of Asia. Among the international
settlement, financial transactions amount to nearly 97 percent of all the settlement.
If the Japan and China are in good positions to go on the second stage. Huge
foreign reserves in both countries are effectively used for securing the stability of thefund. MCSA backed by the fund serves the role of providing liquidity safely. The third
stage is straightforward once the arrangement reached the second state.
The US and other western countries may object to the establishment of MCSA.
Given the dominant status of the CLS in the foreign exchange markets, what justifies a
multi-currency system in Asian market although there is still a USD clearing system?
The CLS is a most advanced multi-currency clearing arrangement covering majorcountries, but covers only 4 Asian countries, with the Western strict “global standard”.
Toward the gravity shift of the world’ economic center, Asia is at the stage of taking theinitiative of providing the international public goods.

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The triangle relation among the JPY, the USD, the CHY are very complicated. If
we try to promote the JPY and the CHY either for investment currency or as invoicing
currency, definitely it would undermine the status of USD.

Asian monetary integration needs the research sector independent of IMF.
Multilateral initiatives such as the ASEAN+3 Macroeconomic Research Office(AMRO) are under progress. About AMRO, what you talked is the IMF delink portionof Chiang Mai initiative which is currently 30 percent. The finance ministers alreadyagreed to consider the possibility of 40 percent. Potential recipient countries argue for
40percent, while potential creditor countries including Japan and China, are moreconservative and want to continue to hold it at 30 percent. Since there is call for an
increase in the IMF delink portion, I think eventually 30 percent would be raised to 40
percent. In fact, I have been arguing that this delink portion should be ultimately 100
percent.

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