China's Political Rise and Japan's Economic Risk: Multinational Corporations and Political Uncertainty

China's rise has created countless economic opportunities as a destination for foreign direct investment for multinational firms seeking low manufacturing costs and the promise of a burgeoning middle class consumer market. Political conflicts with neighboring countries, assertive and aggressive nationalism, and China's authoritarian institutions, however, are sources of significant political-conflict risk for these firms. Scholars argue that risk from international political conflict depresses foreign direct investment, either by dissuading risk-adverse firms from initially entering a foreign market or by forcing withdrawal after the costs of doing business are too high. While surveys of firm officials suggest that political risk is a key component of their strategic thinking, empirical work shows mixed or no effects of risk on FDI. In the case of China, the gap between the expected importance of political risk and actual investment flows is stark and puzzling: economic relationships seem robust even amidst high levels of political conflict risk. How do business actors respond and cope with political tensions and risks? ;Existing literature neglects two crucial elements of economic exchange across borders that help answer this question: how firms perceive political conflict risk and the menu of options of act as mediating actors and manage the risk. Using interviews with state and business actors in Japan and China and statistical analysis of unique and original datasets, I show that nationalist tensions and conflicts do not curb trade or investment flows because of heterogeneity in how firms perceive and experience risk, and the subsequent risk management behavior that strategically responds to escalating tensions. Firm's experience and perception of political-conflict risk predicts their actions: firms with greater risk exposure engage in corporate responsibility activities designed to transform Chinese society into an environment more friendly to Japan. International diversification follows a similar pattern, where firms with interests in politically charged sectors such as natural resources aggressively diversify to mitigate the effects of political conflict risk.