Both countries claim sovereignty over the rocks, which a private Japanese family has owned since 1972. Complicating matters, Taiwan also claims the Diaoyu islands—and China still claims Taiwan. Earlier this year, Tokyo’s mayor announced the city government’s plans to purchase the islands to ensure China couldn’t seize them, which set off the current three-way spat. It boiled over earlier this month, when the Japanese government purchased the islands—in response, China deployed military vessels and threatened economic retaliation, and Chinese citizens protested Japanese businesses and embassies around the country. (For more on the dispute, see this excellent analysis from Simon Tisdall in The Guardian.)
In the wake of China’s actions, I’ve seen several articles suggesting the dispute could have a detrimental impact on trade between the two—with Japan’s economy bearing the brunt of it. Based solely on the size of each nation’s economy and China’s trade deficit with Japan, that might seem plausible—however, it’s not that simple. As the world was reminded after last year’s Great Tohoku Earthquake and Fukushima Daiichi nuclear disaster, Japan is still an important piece of the global supply chain. Autos, computers and other high-tech electronics—products manufactured in China—depend on Japanese parts. Severing trade ties with Japan could make life difficult for Chinese manufacturers, and I suspect the government understands this—Chinese officials are likely too pragmatic to make good on their threats.
Over at The Telegraph, Jeremy Warner took things one step further and suggested trade tensions between China and Japan are the latest development in a longer-term trend of creeping but subtle global protectionism. The article’s an interesting read, and it is true protectionist measures like export subsidies are on the rise. However, his conclusion that global trade will suffer because of this seems off base. Tit-for-tat trade restrictions and disputes have existed for ages. Yet global trade has risen steadily over time and is nearing its pre-recession highs, as shown below. High and rising trade doesn’t square with rising protectionism.
Exhibit: Global Trade, 1990 – 2010
Source: World Trade Organization.
Rising trade, in my view, is strong evidence that despite the rise in subtle protectionism, trade is getting freer. Looking forward, the benefits of all free trade agreements implemented in recent years should vastly outweigh the negative impact of mercantilist policies in some nations, and several more free trade agreements are in progress. A rise in protectionism would be a legitimate risk to the global economy and equity markets, but for now, it seems highly unlikely.