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Senkaku Islands Conflict Threatens China's Stable Image

China’s conflict with Japan over the Senkaku Islands threatens China’s image as a safe place to invest.

In the short term the smashed shops and shuttered factories of Japanese companies in China suggest that the dispute over the Senkaku Islands, which has prompted demonstrations and vandalism in more than 80 cities, will be worse for the former country than for the latter. In the longer term, however, the Middle Kingdom may suffer the greater harm — on the grounds that a damaged factory takes only days or weeks to restore but rebuilding a good name takes decades.

The Senkaku Islands — known as the Diaoyu Islands in China — are in an awkward place, lying either on the very edge of Japan or the very edge of China depending on whose side one takes. The two parties cannot agree on who owns them and the 41-year-old argument took a turn for the worse earlier this month when the Japanese government decided to buy three of the islands from a private Japanese owner despite Chinese warnings against such an allegedly provocative action. Tit followed tat, escalating into violence by Chinese citizens.

If popular protest over the island chain continues, the share prices of Japanese companies with disrupted operations in China will be hit. The carmakers Mazda, Mitsubishi Motor and Sony, and the retailers 7-Eleven and Uniqlo, shut their outlets temporarily for safety reasons in response the protests. This disrupted production and sales, though they all reopened earlier this week.

Prolonged organized boycotts, or alternatively the simple growth of a generalized distaste for any Japanese products among Chinese consumers, could also badly affect those companies, including the electronics manufacturers Rohm and TDK, which make more than a quarter of their sales in China. At a national level Japan’s exposure to China is high: The country accounts for about 20 percent of Japanese exports, whereas Japan accounts for only 8 percent of China’s, and the gap between the two figures is growing wider.

Nomura, Japan’s biggest securities house, has so far been fairly sanguine about the effects of Chinese discontent on companies’ long-term prospects, saying, “Markets have a tendency to overreact to events of this kind.” Nomura notes that although the share price of Japanese retailer Aeon, for example, fell after a Chinese boycott of Japanese goods in April 2005 over Japan’s bid for a permanent seat on the United Nations Security Council, it rebounded two months later. Nomura even adds, “We will be cautiously looking for buy signals on stocks that have fallen as a result of these events.” There have not, as yet, been many dramatic slides — though shares in the retailer Heiwado, which has suffered damage and looting to Chinese stores, have dropped by 5 percent to ¥1,138 since the protests started. 

However, in the longer term the images of Chinese citizens smashing foreign multinationals’ property send dire signals about the country’s suitability for foreign direct investment (FDI). Morgan Stanley says in a research note published late last week: “China’s economy is weak, struggling to find a better footing. Uncertainties concerning foreign investment in China will not help to kick start the Chinese economy.” The list of companies that have suffered physical damage includes some of the biggest Japanese investors in the country, such as Toyota and Panasonic, and at least six retail companies.

The news late last week that Japanese freight companies operating in China are experiencing delays and more severe than usual inspections of paperwork is a twist to the saga that could cause further harm to the country’s reputation as an offshore partner.

China has become the premier workshop of the world in recent years in part because it has managed to restrain deep-rooted tendencies towards industrial and social instability — sufficiently, at least, to allow foreign companies to run relatively smooth operations, for the most part, in the country.

China’s rivals as manufacturing centers, meanwhile, are far from paragons of social stability. Vietnam, a growing center for foreign direct investors, including Japanese manufacturers, is prone to wildcat strikes. In India, Maruti Suzuki, a joint Japanese-Indian joint venture and the country’s biggest carmaker, was forced earlier this year to shut its Manesar factory for a month after rioting workers killed a senior manager.

It can, in short, be said that China still retains a competitive advantage in stability, which is as important a competitive advantage as labor costs and infrastructure.

However, the emergence of a large-scale protest movement, directed against one of China’s key foreign economic partners, which has spread to more than 80 cities, jeopardizes this edge. If China loses this advantage, the FDI that has fueled much of the growth in its economy — and therefore in a broad range of asset prices, including equities and property — will unwind to a spectacular degree.

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