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In a briefing for local media shortly before his departure for Beijing, Uichiro Niwa, Japan’s new ambassador to China, was blunt about the need for Tokyo to accelerate efforts to seal a free-trade agreement between Asia’s two biggest economies.

“If we don’t make progress on an FTA, then Japan will sink,” said Mr Niwa, a former president of Itochu, the trading house, and the first non-career diplomat to head the embassy since Japan established diplomatic ties with communist China in 1972.

Such comments may tend toward hyperbole – the real keys to Japan’s economic health are more likely to be found at home – but there is no denying the growing importance of the nation’s fast-developing neighbour across the East China Sea.

In the second quarter of 2010, China surpassed Japan as the world’s second-largest economy in market dollar terms. In 2009, sales to China accounted for a record 19 per cent of Japan’s overall exports, eclipsing the US for the first time, according to the Japan External Trade Organisation (Jetro). Japanese imports from China last year accounted for 22 per cent of the total – also a record.

Parallel to China’s growing importance as a trade partner to Japan is a broadening and deepening of the economic relationship. Many Japanese companies used to think of China mainly as a cheap place for the final assembly of products for shipment elsewhere. But now even the most cautious enterprises are increasingly aware of China’s potential as a source of final demand – a feeling heightened by Beijing’s success in shrugging off the effects of the global economic slowdown.

At the same time, the growing sophistication of China’s manufacturing base and the maturity of Japanese-invested operations mean industrial supply chains are becoming more tightly enmeshed. The cars, electronics and other goods produced by many Japanese companies are the product of complex supply chains linking factories throughout the region, with Chinese factories often responsible for high-tech parts as well as low-cost assembly.

“The trade is now horizontal,” says Yasuo Onishi, president of Jetro’s Shanghai office.

Japan’s powerful sogo shosha, or general trading firms, have benefited hugely from soaring Chinese demand for commodities ranging from gas to iron ore, but are now increasing their direct investments in the country and creating complex enterprises in which the role of their home market is often peripheral. Marubeni, one of the country’s biggest trading firms, has invested in a bakery in Shanghai that uses wheat it supplies. A Mitsubishi affiliate in China imports polyethylene sheets from a Mitsubishi-invested petrochemical company in Saudi Arabia to make plastic bags that are exported for use in Mitsubishi-invested fast-food and retail outlets in the US and Japan.

China’s growing wealth and the emergence of an urban “middle class” with significant spending clout is seen by some Japanese as a source of salvation from the troubles of their domestic market, where demand is being undermined by anaemic growth and a declining population.

Chinese consumers are seen not just as buyers of manufactured products such as cars and home electronics, but also as potential customers for service-based businesses such as spa resorts and restaurants. Robots, high-tech toilets and medical equipment all drew attention at the Japan Industrial Pavilion at Shanghai’s ongoing World Expo, but the queues outside stalls offering fried squid balls and Japanese sweets showed the potential for less traditional sales.

Tokyo is also making it easier for Chinese consumers and their wallets to make the trip across the East China Sea amid gradual acceptance that their importance as a source of economic growth outweighs worries about illegal immigration.

Just a year after approving individual tourist visas for Chinese, Japanese authorities in July relaxed a requirement that they demonstrate an annual income of at least Rmb250,000 ($36,900).

Now, would-be Chinese visitors must merely possess a “gold” credit card, usually held by people with an annual income of Rmb60,000 or more. NHK, the national broadcaster, reckons this step could help raise the number of visitors from Asia’s fastest-rising economic power roughly six-fold to 6m by 2016.

Yet China’s rise is creating new challenges for Japanese businesses – and the very allure of its huge market also generates its own risks.

Manufacturers of the trains used in Japan’s famous Shinkansen railway system, for example, once dreamed of playing a central role in the development of a Chinese high-speed rail network expected to grow to an incredible 9,940 miles by 2020. In an apparent step toward the goal, a Japanese consortium led by Kawasaki Heavy Industries (KHI) in 2004 sealed a Y140bn ($1.65bn) deal with CSR Qingdao Sifang under which the Chinese government-owned firm would build versions of the E2-1000 Shinkansen trains for sale to the state rail system.

But just six years later, KHI and its fellow consortium members are reduced to the role of high-speed train spotters. Rolling stock that looks identical to the E2-1000 is rolling rapidly off the Sifang production lines, but the Chinese company says it has fully “digested” and improved all the technology involved and that its products now have “nothing at all” to do with Japan.

Indeed, China is already marketing its new high-speed railway expertise internationally, making it a potentially potent competitor on projects around the world.

A Japanese executive familiar with the 2004 deal recalls that members of the KHI-led consortium realised the deal might help give China a start in the industry, but that they “could not imagine” the catch-up would be so fast.

Nor does China’s rapid economic growth rate mean automatic profits for Japanese companies doing business in the country. A recent Jetro survey found the proportion making a profit there has been steadily declining over the past five years to only slightly more than 50 per cent in 2009.

In a reflection of the increasing complexity of business ties, the Japanese Chamber of Commerce and Industry in China this year for the first time emulated European and US counterparts by issuing a white paper explicitly listing their “recommendations” for regulatory liberalisation, tax simplification and intellectual property protection.

While the white paper highlights corporate worries and the continuing difficulties of doing business in China, it should be seen as a signal of even closer Sino-Japanese economic ties ahead. After all, the same Jetro survey that reported falling profitability also made clear that Japanese companies were far from giving up – more than 60 per cent of its respondents were planning to expand their operations in China, it found.

Additional reporting by Jonathan Soble in Tokyo

Copyright The Financial Times Limited 2018. All rights reserved.

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