With great power...

China's economy commands global respect, however grudging... if only the same could be said of its diplomatic approach

Assuming the numbers all hold up to scrutiny, 2010 seems likely to be remembered as the year China's economy overtakes Japan's to become the second largest by GDP in the world. Although the change of position itself is held largely meaningless by economists (Financial Times 2010.08.17 article "Rise of China's economy signals shift in power"), the nominal metric comes at a time when the world is feeling the pull of trade with China.

Chinese demand for industrial and construction machinery has fueled a strong recovery in Germany, the European Union's economic powerhouse. China's conversion from "socialism with Chinese characteristics" to the capitalist equivalent led to the July 6 IPO of the Agricultural Bank of China – at $22.1 bn, the largest ever. Taiwan's legislature confirmed on 2010.08.18 a historic trade agreement, overcoming historical skepticism and diplomatic friction with the mainland Chinese government for closer economic ties. Hong Kong, for decades the region's investment linchpin, has aligned its stock exchange hours with the mainland. The primary reason – anticipation of relaxed currency laws allowing direct purchase of renminbi-denominated bonds, in keeping with China's call for a new world reserve currency.

These indicia of growing global power may be good news for cementing the Chinese Communist Party's legitimacy at home – especially in the face of natural disasters and sporadic ethnic violence. However, they come with an inconvenient drawback overseas: they make China's international policies a more tempting target for criticisms calling for greater multilateralism. In his "Rise of China" article above, FT reporter Jamil Anderlini states that China's leadership has traditionally held to its status as a developing nation, which "cannot be expected to lead global initiatives or take difficult steps such as floating its currency to address trade imbalances." In short, Anderlini's article voices the growing sentiment that China's economy makes it a global leader, but its policies have yet to catch up with a leadership role, remaining more aligned with securing its partial and "narrow self-interest."

The Bush administration's primary international efforts went towards containing Islamic extremism, a single-minded focus that indirectly left Asia, Latin America, and Oceania to China's diplomatic overtures, absent the anti-terrorism spin. Media coverage tended towards a sense of waning U.S. interest in the area. 

In recent months, however, inter-Korean tensions spiked with the March 2010 sinking of a South Korean vessel, the Cheonan, precipitating a U.S. military return to the region and August 2010 military exercises. Coverage of this U.S. shift back to Asia has taken on a tinge of U.S. diplomacy making up for lost time, as well as a sense that China's days of free rein in the region are coming to an end. Whether the Americans are back as competing participants or as destined arbitrators depends on whom you ask.

Image copyright of Financial Times.
Hillary Clinton plays a mean game of ping pong.

In the view of the Financial Times 2010.08.10 opinion piece by Geoff Dyer, it's the former. America's return to Korean waters is significant, he argues, but not unheralded – given the increased naval buildup by China, India, South Korea, and Australia. Hillary Clinton's offer of U.S. mediation in South China Sea disputes was the opening volley in a "diplomatic battle [...] a tussle between the US and China to be the dominant voice." The statement is striking, but merely a resumption of America's post-Cold War policy towards China; a mixture of diplomatic containment and economic engagement. The momentum, however, still remains mostly on China's side, despite discomfitures in Vietnam's closeness to Washington and South Korea's grim resolve in the face of North Korean provocations. Dyer's primary metric is China's breakneck growth, with economic integration playing a much deeper game than sporadic diplomatic points.

Image copyright of The Economist

In The Economist's Banyan column of 2010.08.14, however, the strident mood was apparent from the headline: "They have returned", over an illustration of an American warship on the horizon paradropping a smiling mouth onto Chinese territory. The article described a general loss of Chinese diplomatic initiative, with China's "swagger, bordering on arrogance [...] throwing their weight around the region" suddenly reduced to a notion that "courtesy is back in vogue". Colorful descriptions attributed an impotent Chinese leadership fuming over perceived slights and snubs, as the Americans regained their diplomatic stride among Southeast Asian nations grateful for deliverance from the Chinese behemoth. The Obama administration has played down this conduct, opting instead to portray it as America protecting its own interests in the Pacific. Banyan, distrustful of this, urges America to go one further and opt for containment with a muscular strategy.

Triumphalism aside, Banyan hits upon a perennial problem for Chinese geopolitics. Border disputes currently comprise, and have long been, a major challenge for China, who (tied with Russia) has the largest number of foreign frontiers of any nation in the world. (17 frontiers with 14 different nations: North Korea, Russia, Mongolia, Russia again, Kazakhstan, Kyrgyzstan, Tajikistan, Afghanistan, Pakistan, India, Nepal, Bhutan, Burma, Laos, and Vietnam – Hong Kong and Macau also have manned borders under the "one country two systems" status.) At sea, too, the Chinese maritime claim covers most of the Yellow Sea to the east and the South China Sea to the southeast, triggering disputes with Japan and Korea over the Senkyaku Islands, and Vietnam and the Philippines over the Spratly Islands. Although China recently resolved several outstanding border disputes with Russia, it has never fully resolved its Kashmir border with Pakistan and India, nor its Aksai Chin border just north of India's narrow corridor with Bangladesh. For a nation bordering 14 foreign borders, China's innate sense of its place in the world, and how to approach it, may well differ significantly from America's (three borders, two neighboring countries) and Britain's (zero borders, one tunnel).

Banyan also hits on the main thrusts of America's renewed diplomacy in the region: a rapprochement with former wartime enemy Vietnam, a robust display of military unity with South Korea, and a greater voice in the ASEAN and other Asia-Pacific economic forums. Rumors of the death of American interest in the region, it asserts, were overblown. Looking at the pre-Cheonan sentiment of American commentators, such a conclusion is tempting. In a May/June 2010 Foreign Affairs piece "The geography of Chinese power" (abstract), Robert D. Kaplan considers China's land and sea holdings and reflects on a future where China's projection of power extends deep into both Central Asia and the Pacific Ocean. Coupled with a nondemocratic government capable of effecting rapid policy changes, Kaplan's view of China is a nation undergoing a similar rapid expansion of international interests and power projection as America underwent in the 19th Century.

To label Kaplan as defeatist, however, is overstating the point. Kaplan emphasizes the possibility of military conflict between the two nations as remote, and points to differences in mission outlook as the main sources of geopolitical friction. China's expansion is driven almost entirely by economic interests and the securing of raw materials and commodities, with little interest in how its trading partners govern themselves. America's expansion was (and still is) driven by "a missionary approach to world affairs, seeking to spread an ideology or a system of government". Kaplan acknowledges the complex border history with Russia and Mongolia, both borders secured in historical conflicts which the current Communist leadership has agreed to observe, and points to China's primary engine of maritime expansion to the southeast as trade – with a naval presence primarily designed to protect commerce. Kaplan also argues that China's naval buildup could be a force for stability in the region, especially if American military communications improve to the point where the PLA Navy can be co-opted instead of contained. Whether this is feasible is a separate question entirely: recent developments suggest it will be a bumpy ride at best. (FT 2010.08.17 "Pentagon hits at Beijing's military secrecy".)

Perhaps most noteworthy is the neat, if unremarked, symmetry in the rationales for both sides of the rivalry. Banyan cites aggrieved Chinese op-eds decrying American duplicity: "Sweet-mouthed [American politicians ...] stab you in the back when you are not looking" while Kaplan cites Singaporean politicians leveling much the same charges against China: "The Chinese charm you when they want to charm you, and squeeze you when they want to squeeze you." Likewise, Banyan's skeptical observation of America's official story of self-interest (and Banyan's mild admonition that this is not going far enough) is especially reverberant among observers, such as 

Anderlini, 

who take the view that China's growing power should move it beyond simple self-interest.

Though both rivals may be reluctant to admit it, both nations share strongly similar interests in the area, and moreover their methods of handling it are converging rather than diverging. As long as the trade ties continue to bind, military tensions will likely remain a sideshow, a softkey dance, a tacit mentorship.

Soaring surpluses, international integration – and a quiet shift to second place

China's economy overtakes Japan as the world's second largest
In recent years, the talk has turned from whether China's economy will overtake Japan's, to a question of when. This 2010.08.15 New York Times article by David Barboza strongly suggests that this milestone has occurred:

"The recognition came early Monday, when Tokyo said that Japan’s economy was valued at about $1.28 trillion in the second quarter, slightly below China’s $1.33 trillion."

The article notes that at Japan's economic peak in the 1980s, talk turned to whether it would unseat America as the world's largest economy. Today, its industries are mature, its standard of living on par with other developed nations, and its population is ageing. By contrast, China is still urbanizing, with a standard of living closer to most developing nations, with "a lot more room to grow". (Demographically, there may be an age crisis to come as the Chinese one-child policy results in retirees outnumbering the workforce in future decades: a scenario commentators have referred to as "growing old before growing rich".) The article emphasizes the familiar set of challenges ahead: 

• an economy too reliant on exports, 
• insufficient support from domestic consumption and the economic infrastructure to encourage the same, 
• questionable financial policy by state-run banks lending irresponsibly and evading accountability,
• environmental impact of industrialization, having overtaken the U.S. as the world's primary greenhouse gas emitter

More positively, it also covers the familiar territory of China's disproportionate influence in commodities markets (most notably iron, coal, and oil), and the attraction of foreign investment. However, Barboza's article ventures briefly into unorthodox American journalistic territory by giving some credit to the authoritarian government in China, acknowledging its ability to implement quick responses and take decisive action, emerging more quickly from the global recession than many developed nations and pulling the region out along with it.


International integration – and roadbumps
Despite this numerical metric, viewing the two nations as rivals sheds little light on the trade relationship. Japanese businesses have seen considerable benefits to doing trade with their primary Asian neighbor. An early beneficiary of China's cheap labor workforce, Japanese corporations have adapted to rising wages and found a ready market for their own products and goods. A growing Chinese middle class has spurred keystone joint ventures such as a massive 2,100-unit residential project in Dalian and a 160-store outlet mall in Ningbo (2010.08.11 Financial Times article: China lures once-shy Japanese developers). FT's Michiyo Nakamoto writes that this growth industry owes its success to several factors: a) saturation in the native Japanese markets, b) significantly greater demand than supply – 200 million urban households alone, with only 80 million added from 1999 to 2009, c) generous profit margins compared to the domestic Japanese market, and d) an expertise gap among Chinese corporations, few of whom have the experience of overseeing an entire mall project from start to finish, and with a notable existing advantage over the lower quality of Chinese workmanship.

Germany, too, is another economy helping its region out of the global recession, and racking up a large trade surplus while doing so. Like Japan, Germany has a strong reliance on Chinese demand for its exports, so much to the point that some experts say without Chinese demand, the recovery in Germany's textile machinery sector would be invisible, and German auto makers would be heavily hit. (2010.08.16 Financial Times article: Analysis – Germany: On a roll). The prevailing mood is "summery" according to FT's Daniel Schäfer, but an underlying fear remains of what might happen if the Chinese boost stutters. Conversely, whether Chinese entrepreneurs can reverse the flow and crack into Germany's iconic engineering machinery industry remains to be seen – but Chinese corporation Sany is leading the charge with fellow rival Zoomlion close behind. (2010.08.11 Financial Times article "Chinese push into Germany's heart and soul".)


...and an embarrassing surplus
Given the continuing manufacturing slump in America, and the moribund revaluation process of the Chinese renminbi yuan, it's likely that the recent news that China's surplus hit an 18-month high has done little to lift the American sense of grievance. (2010.08.11 Financial Times article "China trade surplus at 18-month high".) However, currency manipulation (though a sensitive political subject) is seen by Financial Times' Lex columnist as a non-factor in China's surplus. The main factors are:

• Government emphasis on export industries, which are privileged,
• Domestic demand so far tends towards products already made locally, because of tradition and demographics,
• High industrial productivity.

Also noteworthy, the World Bank projects that China's current account balance percentage of GDP – currently at 6% – will shrink considerably over the next few years.
Either way, with a GDP at $14 trillion, America's economy is more than ten times the size of China's. 2010 may be the year China overtook Japan, but for America, that prospect is still some ways off – 2030 at the earliest.

Care and maintenance of golden geese

China's government weathered the global recession with enviable growth rates. In the aftermath, it continues to apply cooling mechanisms to its breakneck economy. Amid fears of a double-dip global recession, these cooling mechanisms are coming under scrutiny and criticism.

Breakdown of the 2008 Chinese economic stimulus plan.
Image source: Economic Observer.

As the global recession hit in 2008, China's government authorized a stimulus plan totalling ¥4 trillion – roughly comparable to the U.S. stimulus package. More than half went to two fields: public infrastructure and disaster reconstruction following the 2008 Sichuan earthquake. The remainder went more or less equally into social welfare spending, technological advancement, and rural development, with a relatively small sum going to sustainable development and educational projects. The plan combined a mixture of central government funding and costs to be born by local and provincial governments.

The stimulus plan helped maintain healthy growth for China's economy throughout the global downturn, but it is nearing its end, with the central  government reining in bank lending with a hard limit by year's end, and acting to curb speculation in housing and mortgages. The 2010.07.17 Economist article Defanging China's growth indicates that the cooling policies have succeeded – growth has slowed from a rate of 11.9% in the first quarter 2010 to 10.3% in the second: still impressive, but allaying fears of an overheating economy.

The risks of such a slowdown are forwarded in an Op/Ed piece in the 2010.08.06 Financial Times, China needs slower, better growth by Yu Yongding. Firstly, there is a fear that China's economy could jeopardize the fragile global recovery if it stumbles – Yu dismisses this fear in the short term as unlikely, given that even a 9.1% growth in 2009 was a powerful sign amid global recession. His primary fear is that the heavy focus on curbing the housing boom, and the means to combat it (including discussions of taxing property capital gains – a first for China), have taken most of public policymakers' attention away from responsible oversight of infrastructure spending. Although housing is certainly the more socially sensitive topic causing greater public resentment, infrastructure spending was the recipient of the largest share of the stimulus funding. and bear long term consequences if it fails to meet similar gains in manufacturing: roads that lead nowhere collect no tolls.

The worst-case scenario Yu posits would be a 30% fall in house prices, and then only if the government fails to implement controls responsibly. This is unlikely, given the low debt of Chinese households and well-capitalized banks by government regulation. The more pressing long-term concerns involve the country's over-reliance on two fields: a) investment, which will eventually plateau out and risks deflation, and b) on exports, which have already encountered growing protectionist resistance owing to their sheer mass. Developing structural safeguards and improving quality over mere quantity remain key goals for the leadership according to Yu.

Both within China and outside, the effects of a Chinese slowdown are making themselves felt. Domestically, inflation grew above 3% in a 2010.08.12 FT report ("Chinese economy slows further"), even as factory gate inflation fell. The prevailing view is that the Chinese economy is undergoing a "controlled slowdown" rather than a double dip economy. Stockwise, the Chinese variances are affecting Asian stock prices in the Asia-Pacific index, the Shanghai Composite, Nikkei 225 Average, and Sydney S&P/ASX – with marked losses for Chinese property development companies, and drops for materials stocks in the S&P 500 in the U.S.

With prospects of a fall in housing prices triggering dissatisfaction among China's newly-anointed homeowner class, longterm concerns such as the friction in foreign markets and the unsustainability of export growth are likely to take a back seat in Chinese policymaking circles. Yu counsels engagement sooner rather than later – advising that a greater delay will result in a more painful adjustment.

Shifting premises: a drive inland for China's labor force

Historically, the coastal provinces have underpinned China's status as an international  trade power. Expatriate communities of overseas Chinese are still disproportionately represented by Cantonese-speaking emigrants from the coastal south. In the late 1980s, with the dismantling of the communes, paramount leader Deng Xiaoping chose port locations as his four seedbeds for capitalist experimentation. Throughout the 1990s and the 21st century's first decade, the provinces nearest the sealanes have sustained the lion's share of China's growth.

Now, however, that pattern may be changing. There has been a growing income inequality between the prosperous coast and the backward hinterlands, but much of this is predicated on the availability of cheap labor. A spate of industry actions at foreign firms' factories in the southern province of Guangzhou suggest that China's coastal workers are growing more vocal in demanding their own spoils of growth: higher wages and improved working conditions.

Image copyright of TheTransportPolitic.com

Against this backdrop, the hinterland provinces – long held as trade-poor backwaters – are drawing increased interest as industrial bases. In a 2010.08.04 article, Geoff Dyer and Zhao Xue of the Financial Times report that inland provinces such as Anhui, Jiangxi, and Hunan are seeing a boost in industrial growth. The main factors spurring this are: a) uncertainty about sustainability of coastal growth rates (especially given recent industrial disturbances), b) government stimulus spending to counteract the global recession, and c) recent completion of high-speed road and rail links, reducing the cost of doing business with the interior.

The benefits are clear. Market forces may accomplish what the post-command economy has struggled to enforce – the narrowing of the wealth gap between coast and interior, with the attendant reduction in social tensions. Additionally, the traditional movement of hukou-unregistered vagrant workers from the poorer areas to the wealthy coastal cities may reverse: with better prospects for employment back closer to home, migrant workers may shun the higher wages and costs of living in the cities for a wage-earning post nearer their families and ancestral homes. As worker income rises and stable jobs retain local hands, the demand for homes rises too. FT cites the opening of major foreign supermarkets Tesco, Carrefour, and Wal-Mart, as well as mid-management bank HSBC, in Anhui province's capital of Hefei as a sign of growing consumption growth.

Economically, too, there have long been fears that China's exports-driven economy has neglected to build a domestic consumer base, leaving it vulnerable to fluctuations in foreign trade. A redirecting of wealth into inland households may give millions of citizens the wealth they need to establish just such an infrastructure.

These are not without their risks, however. In the wake of the growing costs of labor in coastal regions, foreign firms are considering the interior as only one of several options, and Vietnam and Bangladesh are cited as possible rivals. Additionally, much of this growth reflects the effects of the government stimulus plan – which is rapidly coming to an end.


In a sidebar, the reporters examine the effects of urbanization. Noting that the much-maligned hukou registration system, tying a citizen to a given city for education and health care, has helped to avoid much of the shantytowns that plague other developing nations, the article nevertheless identifies hukou laws as a major area for legal reform. Residents working outside the ambit of their hukou permits currently risk forced relocation, police harassment, economic exploitation – and surrender most claims to state health and education support. The existence of this unofficial stratum of second-class citizens within their own country fuels significant social tensions.

The household of Chongqing resident Wu Ping, after a 3-year
standoff with local developers over land use compensation.

Additionally, the authors note the issue of public repossession of household lands as a serious issue. As urbanized areas grow, the traditional method of raising state funds is through land grants. Given China's communist past, few of the residents currently living on the granted parcels have legal title to the lands. In American legal terms, this taking would be similar to eminent domain takings. In China, where private property laws only came into effect in the last four years, and where conflicts between developer and homeowner can wax intractable, these households get by with an earthier nickname – "Protruding Nail Houses".


Update: in an op/ed piece Watch China's coasts not the currency, Yukon Huang (of the Carnegie Endowment) states that China's currency peg does not notably contribute to China's economic development, nor does it slow global growth. Rather, domestic growth owes its greatest debt to Deng Xiaoping's focus on the "three D's": a) density of economic activity restricted to a few coastal areas, b) distance reduction by expanding transport services, and c) division reduction by eliminating barriers to the movement of goods.

Huang refers to the positive effects of the migrant worker labor force, crediting it with raising 500m people out of poverty and contributing to double digit annual GDP growth. He holds currency policy as only a bit player in overall growth, especially as compared to saving and investment rates, pointing out that when China allowed its currency to appreciate in the 2005-08 period, China's trade surplus grew rather than shrank.

Huang believes that the Chinese leadership, having secured its goals of economic growth in the coastal provinces, will now switch priorities towards rebalancing the wealth between hinterland and coast, down from the current imbalance whereby the coastal households have triple household income of the interior households. Inflated wages and property prices on the coast will spur a move inland, helping restabilize income disparities.

Huang hypothesizes that an appreciation in the currency as the West is calling for would do more harm than good, contributing nothing to a shift inland nor to a rise in consumption. Much of his analysis pits the more recent focus by economist Paul Krugman on China's currency against Krugman's own earlier economic theories, which would suggest the currency issue is less significant.

Changes on the world's factory floor

An argument in recent years runs thus: China's export-driven economy enjoys an unfair advantage in its supply of cheap labor – whereas production prices in developed nations are fettered by such concerns as labor unions, minimum wages, and a stronger respect for human rights. Taken to its conscientious conclusion, the argument goes, American households should shun Chinese goods and American businesses should demand a level playing field before doing trade with a non-participatory command economy.

Simplistic perhaps, but with a few truths to it. For years, much of the Chinese economy has relied on the undocumented labor force of rural migrants seeking work in violation of the hukou system, which makes leaving one's registered economic hometown difficult. Those who do bypass the system eke out a living as migrant workers, with few rights and fewer still avenues of redress. Naturally, with little other choice, such workers have formed the backbone of China's cheap labor force, sustaining the breakneck rate of development for years.

Foreign firms and laborers alike have noted this dubious supply of labor, but have generally met with limited success in changing the market. This has held true of the consumer habits of U.S. households, which have continued to purchase cheap goods, from luxury items such as flatscreen TVs to basics such as furniture and tools. It has also held true of the situation on the factory floor in China, where the government has proven more concerned with sustaining its fragile boom than it is for worker welfare.

Image property of The Economist. Chinese caption reads "What do we want? More money! When do we want it? Now!"

However, a series of high-profile worker's grievance issues over this past summer, involving strikes at Honda and Toyota, and a spate of suicides at Foxconn, have shaken the image of Chinese workers as uncomplaining laborers, and hint that the era of an infinitely pliable Chinese workforce may be coming to an end.

The 2010.07.31 issue of The Economist mused on the socioeconomic implications, with the primary points being:

• 2008's new labor law will incentivize workers to bring suit for redress, and demographic change in the 15- to 29-year-old age group will reduce the amount of available workers;
• China's government, though historically heavy-handed in its quelling of strikes, may be more willing to let workers air grievances against foreign firms;
• A rise in workers' wages and living standards would in turn help wean China's economic growth off its heavy reliance on exports to include greater consumer spending;
• As China's advantage with a cheap workforce plateaus out, it will come to emphasize a skilled workforce – which in turn will require revisions to its hukou system and a greater focus on the training and wellbeing of individual workers.

The change may be later in the dialog than expected for proponents of the "Chinese workers deserve better" school of thought, but it appears to be gaining in traction.

Perhaps most noteworthy, however, is the fact that the greatest engine of change appears to be coming from the factory floor itself. It's indignant Chinese workers, and not indignant foreign commentators, that are driving the recognition of workers' rights.