The rate at which the US is recovering from recession is the slowest since World War II. Meanwhile, the Eurozone and the UK have not yet recovered the economic losses of the past years; the Eurozone is creeping out of recession at a snail’s pace. In Latin America, growth has slowed. In addition, whereas some African economies are growing fast, in economic terms the continent is far too small to lead the way for the global economy.

Theoretically, Asia could act as an economic catalyst. Its population represents 27% of the total world economy. To quote Stephen Bird, CEO for Citi in Asia Pacific: “By the middle of this century we expect Asia to account for close to half of the world’s gross domestic product (GDP). By 2030, we are forecasting China and India to be the largest and third-largest economies in the world.”

Citi’s Bird bases his optimistic view on the economic fundamentals. Investors are also looking at the political situation in the region, and the individual countries, and are less sanguine in their outlook.

Explosive region

Thirty years ago, China’s economy was smaller than the economy of the Netherlands. Now it is the second-largest economy on the planet, behind the US. Japan occupies the third place.

As Kevin Rudd – the former Prime Minister of Australia – wrote in Foreign Affairs: “History teaches that where economic power goes, political and strategic power usually follows.” Increasingly, China is positioning itself as a superpower; ‘great power politics’ is the order of the day in Asia. Political (and often economic) developments are strongly influenced by a raft of sub-regional conflicts and contentious issues.

Asian states are not only worried by China. Many have unresolved issues with Japan that are rooted in recent history. Some believe Prime Minister Shinzō Abe to be jingoist and are afraid that he will rewrite Japan’s pacifist constitution, under which the country is only allowed defensive military capabilities.

With an ever more assertive China, nerves in Japan, the strategic involvement of the US, and a raft of smaller countries that need to protect their interests in this geopolitical cauldron – it is clear that stability is not guaranteed.

Chinese-Japanese enmity

First, what do its neighbours think of Beijing’s attitude? Nine out of ten Japanese and Koreans take a negative view of the ascent of China, and so do more than 70% of Australians and two-thirds of Filipinos.

In recent years Beijing has appeared more willing to enter into confrontation. Its military spending increases year-on-year – by more than 10% in 2013 – and the Chinese are busy constructing their first indigenous aircraft carrier. On hearing the news, many regional leaders may have felt shivers running down their spines. Particularly in Japan, even if Tokyo is also making waves with a new military vessel – its largest since World War II. Ominously, it is named after a Japanese cruiser that was used during the invasion of China in the early 20^th century.

In recent years, there have been many news articles about tensions over the disputed Diaoyu aka Senkaku islands. At the same time, large-scale protests erupted in China and Japan. Chinese rulers started to refer to the islands as “China’s core interest”, thereby placing them in the same category as Taiwan and Tibet.

The political fallout was just the half of it. Chinese riots and protests caused $120m worth of damage to Japanese companies in China, and Japanese auto exports to China dropped by approximately 40-50% as a result of a boycott.

Will they or won’t they?

Not surprisingly, surveys show more than 90% of the Chinese dislike Japan, while 90% of Japanese respondents have an unfavourable impression of China. The thorniest issues are territorial conflicts and unhealed World War II wounds.

Some experts think military budgets of both Japan and China give cause for concern. In the past 23 years, China’s (official) defence budget has increased thirty-fold, while Japan’s military spending has risen for the first time in 11 years. The billion-dollar question is whether there is a real chance that the two countries will lock horns.

The high degree of Chinese-Japanese economic interdependence suggests a large-scale trade war is improbable, while many experts contend that real armed conflict is very unlikely. Not least because the global economy is linked to the Chinese and Japanese economies in myriad ways. This was evident, for example, when Apple suffered product shortages in the aftermath of Japan’s triple disaster in 2011. These days, numerous production chains are global and a country like the US has every reason to go out of its way to prevent escalating Sino-Japanese tensions.

Domestic preventive factors

Other factors also indicate that an outright (trade) war between Japan and China does not loom large. China has so many internal problems such as pollution, corruption, protests, inequality and food security that it can do without squabbles with its neighbours. Before it can afford to take a more assertive stance on the global stage, China needs to tackle some of these obstacles, which are impeding political, economic and social progress.

Japan, too, struggles with various domestic issues: excessively high farming subsidies and an overly powerful agriculture lobby; overregulation; a low participation of women in the economic process; an immigration policy that needs to be reformed; rigid job markets. Prime Minister Abe must know that Japan’s geopolitical standing will deteriorate unless it enacts structural reforms.

Also relevant is that Japan is not automatically inclined to impose its ideology on the world, unlike many Western countries, including the US with its Manifest Destiny in the 19^th century or the attempts to export democracy under George W. Bush. Mostly, Japan has been exclusively interested in its own survival.

Irrational war could still happen

Counter to these arguments – which suggest that geopolitical fireworks are unlikely – other developments could give investors pause for thought. Research into wars that occurred during the past few centuries shows that many wars break out for emotive reasons. Often, economic standing was the dominant motive; revenge frequently played a part.

World War I, a major disaster, showed that nationalist sentiments can be stronger than economic self-interest and rational financial arguments, a matter of heart over mind, even in the highest political circles.

In addition, nations regularly underestimate the costs of war. The Americans, for example, were too optimistic about the efforts and funds needed to win the wars in Korea, Vietnam, Afghanistan and the second Gulf War in Iraq. Should Japan or China too fail to look realistically at the outcome of a potential armed conflict, they will more easily engage in war.

Equally, China could misread the US security commitment to Japan. Richard K. Betts of the Council on Foreign Relations says that the US sends ambiguous signals to Beijing. It is unclear whether the US sees China as a “threat to be contained or power to be accommodated. US policy amounts to a yellow light. Yellow lights, however, tempt some drivers to speed up.”

Misunderstandings, miscalculations, insecurity, jingoism, and populism can combine into a dangerous cocktail, causing escalations that nobody actually wants and that make little economic sense.

Will Asia deviate from the historical norm?

Antagonism between Japan and China is but one of the possible geopolitical dangers in the Far East. Tensions are rife between North and South Korea, and also between Cambodia and Thailand. In these cases too, a level-headed economic analysis would conclude there is no risk of escalation. Yet, smooth relationships are never a given in a shifting political landscape. To quote Prime Minister Rudd again: “History teaches that the rise of new great powers often triggers major global conflict.”

Stability is precarious. Little wonder that the Asian markets have disappointed Citi’s CEO Bird and many others. China and Japan are not expected to unleash tanks, warplanes, and cannons in the immediate future. However, constant geopolitical tension may well distract politicians to such an extent that they fail to implement domestic economic reforms.

Meanwhile, the existing cross-border suspicions, rampant insecurity and raw nerves are not conducive to economic partnerships and integration. On top of this, there are plenty of economic factors that can fuel tensions in the region.

One example is yen weakness. A substantial depreciation of the Japanese currency was an important element of the Asia crisis at the end of the 1990s. In recent quarters, policymakers in the countries neighbouring Japan may well have watched with growing unease as the yen continued to fall.

As ever the region provides many challenges and it will be interesting to see if Bird’s predictions are right.

Source: Thomson Reuters Datastream/ECR