Souring diplomatic relations have put Japanese enterprises in a difficult position, but a large-scale withdrawal is unlikely

In 2012, Sino-Japanese relations hit their lowest point since diplomatic relations were resumed in 1972. This was due to former Tokyo governor Shintaro Ishihara's provocative proposal to "purchase" the Diaoyu Islands, then Yoshihiko Noda government's "nationalization" of three of the islands, and then hard-line stance and upgraded military buildup by Shinzo Abe's Cabinet.

In China, Japan's provocations resulted in anti-Japanese demonstrations and the boycotting of Japanese goods, which led to a decline in bilateral political trust, animosity between the two peoples, as well as rising corporate investment risks.

At the time, it was suggested Chinese policymakers counter Japan's provocations with economic or trade measures, and more Japanese companies considered relocation, divestment or reflux of high-end manufacturing to avoid the risks arising from the deteriorating bilateral relations.

Against the background of the volatile Sino-Japanese relations, Japanese companies in China, which are at the forefront of bilateral economic cooperation, have never been so confused and puzzled.

So will Japanese companies withdraw from China on a large scale? What is their benefit-risk balance?

Japanese companies in China are a manifestation of China's great achievements in attracting foreign businesses and investment, and they have made great contributions to China's development after reform and opening-up.

They have contributed greatly to manufacturing upgrading, job growth and tax payments in China. There are now 23,000 Japanese companies that directly or indirectly employ 10 million Chinese people and make tax payments of more than 70 billion yuan ($11 billion) a year on average. They are also an important source for China to attract foreign investment and learn international advanced technology and management experience.

There are a number of factors that prompt Japanese companies to invest in or withdraw from China, including business factors, political influence, as well as globalization. Regarding business factors, with rising land, labor and rental costs in China's coastal areas and the phasing-out of preferential policies on foreign investment, the relocation of Japanese firms to inland China or countries with lower costs is inevitable.

The souring Sino-Japanese diplomatic relations have put Japanese enterprises in a difficult position. On the one hand, they have a high regard for China's relatively mature industrial supporting system, high quality of human resources, fast growing economy and huge consumption potential. On the other hand, they have to take into consideration labor disputes, business friction and rising costs, as well as the possibility of an economic slowdown in China and social risks caused by friction with China. Street protests in China have prompted Japanese firms to increase awareness of risk diversification while investing in China.

However, it is unrealistic for all Japanese firms to pull out of China, as they cannot throw away $300 billion in sales every year.

Also, there are a number of restrictions on withdrawing capital. According to a business consultant, many Japanese companies enjoyed favorable treatment, such as tax exemptions, when entering China. If Japanese firms want to withdraw prior to the expiration of the contract, they will have to compensate the local governments that supplied land for factory sites and repay the exempted taxes. They will also have to negotiate with trade unions and the procedures are quite complicated and overloaded.

And it would take at least 10 years for their investments to mature if they shifted operations to India, Vietnam, the Philippines, Myanmar and other countries. Although some Japanese firms have considered withdrawing from China, they realize it would be a difficult process. Therefore there will not be a large-scale withdrawal of Japanese investment.

However, in the era of globalization, the transfer of capital and operations in pursuit of profits has become common and we should not read too much into it if some Japanese enterprises do decide to relocate. In fact, since 2010, as a result of labor and electricity shortages, some Japanese companies in China have been gradually withdrawing. The sharp deterioration of bilateral relations has simply accelerated this.

The author is a researcher and director of the Institute of Northeast Asia Studies, Heilongjiang Provincial Academy of Social Sciences.

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