China's rise lifts Japan: the latest figures show that a rising China is less threat than potential savior.

FOR MORE THAN A DECADE, pundits have been hopefully calling the bottom of the cycle and willing the world's second biggest economy to finally recover from the bursting of the 1980s bubble; they have been answered with over 10 years of disappointment and deepening slump.

That long run of misery has generated a view which holds that Japan may now never reproduce the sort of aggressive, export-led growth that made it such a fearsome force in the past. Looming over that reasoning is the growing influence and prosperity of China, and at a quick glance it does appear to pose a colossal threat. China also seems to be aiding and abetting Japan's other chief source of strife by "exporting deflation" to Japan via cheaply produced goods.

The reality is rather different, however, and a flurry of summer numbers have forced Japan's doubters into a rapid rethink. As China holds the limelight with preparations for the 2008 Beijing Olympics and the 2010 International Expo in Shanghai, observers are quietly reaching a strange conclusion. The events in China will likely create far longer-term prosperity for Japan than for China.

Central to the emerging new view is the fact that Japanese exports to China and the rest of Asia have never been stronger, and last year pushed through to record highs. Even the ravages of SARS do not seem to have dented the march of Japanese goods. As China pours its newfound wealth into infrastructure, transport and construction, Japanese companies are ready with the machinery and the basic materials. In Taiwan, South Korea, Hong Kong, Singapore and other parts of East Asia, Japanese companies have already used the years since the 1997 financial crisis in the region to gain a stranglehold on several key areas. Nissan, Honda, Bridgestone and various auto-part makers have all recently reported considerable profits from entry into China. Throughout the Association of South East Asian Nations (Asean), and despite the much-touted competition from South Korea, China and elsewhere, Japanese exports hold the top slot in sales of cars, industrial vehicles, motorbikes and electronic equipment. Calculations by the Japan External Trade Organisation (Jetro) further suggest that since 140 million high-income consumers have newly emerged in East Asia, the market is huge for the kind of products that Japan does best: consumer goods specifically tailored to Asian tastes and needs.

Rather than being a particularly new thing, the strength of Japanese exports to East Asia has simply been forgotten. In 1986, the US was by far Japan's largest export market, with a 38 percent share. By 1991 Asia (including China) overtook the US as Japan's largest export market, and today Asia commands 43 percent of the total compared to 29 percent for the US and 15 percent for the EU. In August the Ministry of Finance was able to add further confirmation of the continuing trend. In the first half of 2003, Japanese exports to Asian countries soared to a record high of [yen] 11.88 trillion. Leading that charge were digital cameras, plasma televisions, audio equipment and automobiles.

But while Japanese companies continue to thrive as exporters to East Asia, a far more complicated trade relationship is emerging with China. More than a third of Japan's exports to East Asia were sent there, and China has also just replaced the US as the biggest importer to Japan--chiefly of food, clothes and textiles. Only recently, however, have those two facts started to be perceived as a good thing for Japan.

As recently as March, large portions of the Japanese government, business press and bureaucracy, primed by years of knee-jerk suspicion of China, were still blaming Japan's continental neighbor for most of its economic woes. That line has been noisily repeated in the light of recent calls on China to allow its currency, the remnimbi, to be released from its current peg. A prominent Cabinet Office report at the end of the financial year explicitly blamed China for Japan's spiraling deflation--a major problem that is still nowhere near being under control--and for "hollowing-out" the Japanese manufacturing sector.

But analysts like Goldman Sachs chief strategist Kathy Matsui have consistently argued that Japan is actually benefiting enormously from its rapidly expanding trade relationship with China. She points out that China buys from Japan more than it sells, and that Japan enjoys a trade surplus with China/Hong Kong. "Since imports from China/Hong Kong represent merely 1 percent of Japanese GDP, it is hard to claim that China is deflating Japan," she says. "Given such rapid import growth from China, many observers are quick to conclude that China is one of the main causes of Japan's prolonged deflation. But total import penetration into Japan is very low. For every 100 yen spent on final purchases of goods and services in Japan, only 1 yen went to goods from China."

Matsui and others blame Japan's deflation and economic slump on a steep decline in domestic capital expenditure, and they find the prospect of wealthier Chinese consumers an exciting one. In the past, the bulk of Japanese exports to China were used for processing and assembly and ultimately intended for re-export to third countries. But the balance has now shifted dramatically and Japanese exports to China are dominated by products that are consumed there directly. Panasonic, Sony and Toshiba sell electrical equipment, mobile phones and televisions. Honda has carved a giant chunk of the motorbike market. Daikin is reaping the rewards of a healthy new Chinese appetite for home air-conditioning systems, and Japanese consumer products companies are doing a roaring trade in up-market soaps and skincare creams.

Several analysts have also said that the current strength of Japan's exports makes China's "economic superpower" tag appear premature. China's GDP may have tripled between 1990 and 2000 but the mainland economy is still only one quarter the size of Japan's with a trade value 35 percent smaller, despite the fact that China's population is 10 times that of Japan.

Japan's advantage is the ability to thaw on its own history for guidance in how to conquer Chinese markets. The strategy taking shape is the same double attack on both the industrial and consumer markets--that Japan tried and tested first on itself, and then later on other parts of East Asia.

On the industrial front, Japanese companies have been quick to recognize that urban China looks now like urban Japan did before the major construction boom of the 70s. Japan was once the recognized expert in making things, and China is providing an opportunity to put that talent to use. Japanese machinery makers and producers of speciality chemicals and metals are doubling and tripling output to meet demand from China. As the Olympics approach, China's efforts to modernize road, rail and communication networks have become ravenous absorbers of Japanese exports. Japan is involved in a hotly contested bid to export wholesale its iconic bullet train as China's new high-speed rail service. China's entry to the WTO in December 2001--seen by many as a critical turning point for Japan above all--will, among other changes, eliminate restrictions on textile imports from China by 2005. In readiness for this, Brother is expanding sales of industrial sewing machines, and is attempting to steal a march on its US and EU competitors with a massive sales drive and boost in production. Japanese steel is especially flourishing. Tokyo Steel just announced net profits for the first time in a decade because of sustained demand from China. On the consumer front, Japan has identified the increasingly wealthy Chinese as a market--with a disposable income now 40 percent higher than it was in 2000--that could potentially have very similar tastes to its own domestic audience.

Taking courage from tougher WTO rules on piracy, Japanese toy companies such as Sanrio and Bandai are joining Japanese publishers and media groups in selling material for Chinese children. Shiseido has just launched its range of 18 different shampoos and skin treatments. Denstu, the world's biggest advertising agency, said that it plans to form a market research joint venture with China to support the entry of Japanese firms.

Corporate Japan, its hunger whetted by a decade of criticism, has spotted the potential of China long before its political and bureaucratic masters. The Japanese government, despite a recent thaw, remains largely in siege mode and has not properly realized where Japan's advantages over the US and EU lie. Recently the first hint of a breakthrough appeared in the form of a short research report from deep within the Bank of Japan. Tucked away in a late paragraph of the lengthy and statistic-filled document was the following admission: "It is obvious and undeniable by any trade theory that progress in the international division of labor between Japan and China benefits both countries. Hence, the direction toward further expansion in trade is not likely to be reversed."