[the national interest]
AS IF a global financial-market meltdown, the deepest U.S. recession in seventy years, an existential crisis in the euro zone and upheaval in the Middle East hadn’t already created enough trouble for one decade, now the unrest and anxiety have extended to some of
the world’s most attractive emerging markets. Just in the past few months, we’ve seen a rough ride for India’s currency, furious nationwide protests in Turkey and Brazil, antigovernment demonstrations in Russia, strikes and violence in South Africa, and an ominous economic slowdown in all these countries.
Adding to the uncertainty, as the carnage and confusion in Syria remind us, is the fact that there is no longer a single country or durable alliance of countries both willing and able to exercise consistent global leadership. The Obama administration and congressional Republicans don’t want to alienate a war-weary U.S. public by spending blood in the Middle East or treasure in Europe. Europe’s leaders have their hands full with the euro zone. And though the governments of emerging markets want a more prominent international voice, they face far too many tests at home to welcome new responsibilities abroad. Because no one is providing predictable leadership, international problems are more likely to become crises in the years to come, and the world’s wildfires will burn longer and hotter.
WITH THIS in mind, it is all the more remarkable that there’s been so little noise from China, especially since the rising giant has experienced a once-in-a-decade leadership transition, slowing growth and a show trial involving one of the country’s best-known political personalities—all in just the past few months. Given that Europe and America, China’s largest trade partners, are still struggling to recover their footing, growth is slowing across much of the once-dynamic developing world, and the pace of economic and social change within China itself is gathering speed, it’s easy to wonder if this moment is merely the calm before China’s storm.
Don’t bet on it. For the moment, China is more stable and resilient than many realize, and its political leaders have the tools and resources they need to manage a cooling economy and contain the unrest it might provoke. This is a country that has come a long way in a remarkably short time. It is now home to the world’s second-largest economy, one bigger than those of its fellow BRICS countries (India, Russia, Brazil and South Africa) combined. In 1977, China accounted for just 0.6 percent of global trade; in 2012, it became the world’s largest trading nation. Today, 124 countries count China as their largest trade partner, compared to just seventy-six for the United States. China is expected to become the world’s largest energy importer later this year, and it’s already the leading carbon emitter, automobile market and smartphone market. Roughly six hundred million of its citizens are now online. All this success has earned the leadership considerable credit with China’s people.
The fact that China has so far avoided the unrest and uncertainty plaguing so many other countries these days is good news for those who depend on China’s strength for the stability of their own economies, but it is bad news for those who hope that China’s leaders will soon begin to adopt new attitudes toward global politics and market-driven capitalism. Outsiders, particularly Americans, have called on China to become a “responsible stakeholder” in the international system and have wished aloud that as its economy depends more heavily on investment in countries and companies in every region of the world, it would begin to behave as a global partner, one that privileges peace and predictability above all else. There is little evidence that this is happening. Beijing continues to limit its involvement in most international disputes to calculated moves to protect its various commercial interests and to diplomatic efforts to blunt U.S. influence and extend its own.
Some have also expressed the hope that a new generation of Chinese leaders will launch a Gorbachev-style drive for political opening at home. But that, too, is unlikely. Though some elite-level Chinese officials are too young to remember the violent chaos of China’s Cultural Revolution of the 1960s and 1970s, they remember well what Gorbachev’s reforms meant for the Soviet Union in the 1980s and early 1990s—and for Gorbachev himself.
Nor should we expect a near-term push to fully dismantle China’s system of state capitalism, though there are plans to try to make it work more efficiently. China’s leaders know they must gradually reduce the role of the state in the economy as they seek to transition away from an economic model that is too dependent on corporate and government investment. The country must also shift from a twentieth-century manufacturing-based economy to a digital-age model that relies on the power of Chinese innovation.
Both these transitions will require a significant transfer of wealth and decision-making power from public to private hands, and although China’s leaders recognize that these changes must come, they have adopted a gradualist approach. The leadership has demonstrated considerable urgency in making changes to China’s banking system and in opening new areas of the economy to foreign investment, but for now, it is working mainly to improve the country’s state-led growth model, not to bury it. State capitalism—a system in which political officials use state-run companies, privately owned national champion firms, state-owned banks and sovereign wealth funds to ensure that China can generate growth, jobs and wealth without empowering potential domestic political rivals or losing control of the pace of development—has been at the heart of China’s success for many years, and it will be central to China’s development for some time to come. State-owned enterprises and the companies affiliated with them now account for more than half of China’s output and more than half of its jobs. Their dominance is easy to document: in 2012, there were seventy mainland Chinese companies on the Fortune Global 500 list, and China’s government owned sixty-five of them.
Nor are we likely to see a pause in China’s military buildup—even if its political leaders have lately adopted a less confrontational approach with the country’s neighbors. In 2012, territorial conflicts with Japan in the East China Sea and with Vietnam, the Philippines and others in the South China Sea sharply intensified. Then, with the elevation of President Xi Jinping and Premier Li Keqiang earlier this year, the new leadership has made a concerted effort to ease tensions in the region and with the United States.
But the military and other security voices are likely to push back against this shift over time. The People’s Liberation Army (PLA) is home to more hawks than any other area of China’s government, and beyond ideological or strategic differences with civilian leaders, future funding levels for the PLA will depend on the military’s ability to maintain the public perception that it is of central importance for China’s security.
Even when its economy has surpassed that of the United States to become the world’s largest, China will still be a relatively poor country with many unanswered fundamental questions about its future. Its single-party politics and its relative social stability have defied apocalyptic predictions for more than two decades, yet its ability to power forward over the near term should not lead us to underestimate the longer-term questions to come.
Not all of its tests will come at home. As China’s growth depends increasingly on expanding and deepening trade and investment ties in every region of the world, the country’s leaders will find themselves involved in many forms of international conflict with which they have little direct experience, particularly in the Middle East, and they are likely to discover that its global economic presence does not imply global power.
Though the restoration of America’s economic dynamism, the redesign of the euro zone, Middle East turmoil and the diverging fortunes of other emerging markets are vitally important stories, China, its challenges and their implications for everyone else will be the world’s most important wild card over the next generation. Given the growing stakes that the rest of us have in its stability, China’s problems will be our problems too.
PEOPLE HAVE been predicting a hard landing for China’s economy and a direct challenge to the Chinese Communist Party for at least twenty-five years. Hedge-fund manager Jim Chanos began warning in 2009 that the country’s real-estate market had moved China’s economy onto a “treadmill to hell.” Wei Yao, an analyst at French bank Société Générale, warned earlier this year that China might soon face a “Minsky moment,” the point at which China collapses under the weight of the debts accrued by Chinese companies. Gordon Chang, author of the 2001 book The Coming Collapse of China, argues that its current slowdown is nothing less than China’s “Lehman moment,” a reference to the largest bankruptcy in U.S. history. Chanos, Wei and Chang have plenty of company, and their warnings may one day be proven right. Whatever the imbalances in China’s economy, however, they are unlikely to stoke regime-threatening levels of unrest in the near future because three decades of go-go growth and swelling national pride provide leaders with considerable political capital.
Give China’s planners their due: they have enacted substantive, far-reaching economic reforms more consistently and for longer than policy makers in any other emerging-market country. In a country long plagued by peasant rebellions, they created movement in a once-static society by enabling hundreds of millions of workers to shuttle between the countryside and fast-growing cities. They invested heavily in the roads, bridges and ports that move products and in the communications networks that move information. In 2001, they defied skeptics by committing the country to the World Trade Organization—and have generally abided by the institution’s rules and rulings. They moved quickly following the onset of the financial crisis in 2008 to stimulate growth and job creation through more spending on the country’s infrastructure. As important, they are resisting further such moves during the current slowdown in order to begin the next phase of reform, one which requires a step away from reliance on state-driven investment and spending.
Changes are also under way in the governance of China’s much-criticized banking sector. Enormous levels of speculative lending have to be better regulated, though as with the European Central Bank the funds are there to recapitalize failing institutions wherever necessary as changes in financial-market governance are made. That is not a long-term solution, but Beijing will likely be able to balance between addressing these concerns and sustaining growth—preventing the near-term hard landing that some analysts expect.
The worrying news for outsiders hoping to profit from China’s growth is that its state-capitalist growth model remains strong. Plenty of foreign companies, including American firms, will continue to profit mightily from their commercial relationships with state-owned companies. But state capitalism hurts foreign firms in two ways. It undermines the foreign multinationals that must compete with Chinese state-owned rivals that are armed with substantial financial and political backing from their government, and it creates all kinds of obstacles and risks for foreign firms investing and operating inside China. Years ago, anxious to gain access to foreign investment, technology and managerial expertise, China opened its markets to welcome all three. Yet, as exposure to these resources began to empower Chinese companies to see foreign firms more often as commercial rivals than potential partners, they began using their connections with Chinese political officials at both the state and local levels to tilt the playing field in their favor. Some Chinese local and corporate decision makers have always opposed the introduction of foreign competition onto their turf.
The latest example of direct state involvement in China’s domestic economy takes the form of China’s creation in 2011 of “strategic emerging industries,” sectors designated as of special interest to the Chinese government, which wants to develop a system of “indigenous innovation” to help Chinese companies climb the value chain. Foreign investment in these sectors is welcome, and some will continue to earn healthy profits for some time to come, but the foreign companies that enter often are forced to share advanced technology with Chinese partners or have it stolen by Chinese competitors, and this problem is likely to intensify over time.
In addition, across a variety of consumer sectors, Western firms now face an increasingly unpredictable operating environment. Beyond familiar stories about information heavyweights Apple, Google and Yahoo and their struggles with the Chinese government, other episodes are less well known. In December 2012, China’s state-run broadcast network produced an investigative report charging that U.S. fast-food retailer Kentucky Fried Chicken was pumping antibiotics into the chicken it sold in China. A month later, KFC sales in China fell by more than 40 percent. Volkswagen, McDonald’s and the French firm Carrefour have received similar treatment in China’s official media. Recent corruption investigations have also focused on the pharmaceutical industry, while antitrust probes have targeted other food companies. Both will probably expand to more sectors in the months to come. Some of these moves are probably intended to deflect public anger at corruption within the ruling party and to blunt foreign criticism of Chinese companies, but as is often the case in China, foreign firms will face increasing regulatory pressure.
BUT IT is the uncertainty over China’s future rather than the country’s current strength that should worry us most. In fact, though it has so far avoided the volatility we’ve seen this year in Turkey and Brazil and the violence of the Middle East, China is the major emerging-market country least likely to develop along a predictable path.
First, there is the question of China’s aging population, a product in part of the country’s one-child policy. In 1980, China’s median age was twenty-two. That number is expected to surge to thirty-eight by 2020 and forty-seven by 2040. There are already nearly two hundred million Chinese citizens over the age of sixty, and by 2025, that number will top three hundred million.
As the total number of workers begins to fall, the economy cannot expand without a significant increase in the productivity of each worker. Without the kind of innovation that creates the technological change that expands production capacity, China’s economy will slow much more quickly than its leaders are hoping—and at a moment when China’s social safety net, still under construction, will meet its ultimate test. Can the reform process help China meet these challenges? That remains to be seen.
Complicating the effort to keep the peace as China rises is the gap inside the country between rich and poor. In 2012, China’s Gini coefficient—a measure of income inequality from 0 to 1, with higher numbers meaning increasing inequality—reached 0.47. Some analysts consider any number higher than 0.4 as a warning sign of potential unrest. Consider, too, that this is the figure published by China’s government and may not be accurate. What do China’s own business elite think of their country’s future? In July 2012, a study published by the Hurun Report, which documents the behavior and attitudes of China’s wealthiest citizens, reported that more than 60 percent of those surveyed had either filed paperwork to leave the country or had already emigrated. More than 85 percent said they send their children to schools in other countries.
The greatest domestic test will come from the endemic weakness at the heart of China’s current strength: state capitalism. Social unrest may challenge the leadership, but state capitalism, the basis of China’s ability to grow its economy and create jobs, will play an enormous role in determining how severe that unrest is likely to be. Though many of China’s largest state-owned enterprises are professionally and competently managed, the state-capitalist system is subject to all the same inefficiencies and corruption risks of any system directed by government, particularly an authoritarian one. Its primary purpose is to create and maintain jobs, achieve investment objectives designed to bolster state stability and generate wealth for the well-connected few, not to unleash creativity that responds to public demand for new and better products and services. That’s why state capitalism is not equipped to create the lasting and broadly shared prosperity on which construction of an innovative digital-age economy will depend.
Further, once you build it, it’s a hard thing to take apart, because those who profit from the system have enough influence within the ruling elite to resist efforts to reform it. Innovation-based, self-regenerating economic success depends on “creative destruction,” a process by which the workers, resources and ideas that once sustained one company or sector are freed to recombine in new forms that then produce new goods and services that meet the evolving wants and needs of consumers. Those who administer China’s state-capitalist system fear creative destruction because they cannot control the ways in which it creates winners and losers or the pace at which it moves. When old industries die, workers lose jobs and wages, and the risk of unrest grows. Even in a free-market system, politicians are blamed for lost jobs and wages, but when the government owns the company that owns the factory, its responsibility for job creation and protection is more direct and more obvious.
State capitalism cannot be maintained indefinitely because China is already losing some of the advantages on which its state-directed, export-driven economy has been based. When then premier Wen Jiabao declared several years ago that China’s development model was “unstable, unbalanced, uncoordinated, and unsustainable,” it was in part because he understood that growth in China had already produced demand for higher wages among Chinese factory workers, a process that will inevitably erode the cost advantages that drew so many foreign firms to outsource manufacturing to China years ago. Today, a growing number of Chinese companies are working to keep their competitive edge by outsourcing their own operations to cheaper labor markets in Southeast Asia.
Other Asian states have been here before. Export-driven growth once lifted postwar Japan out of poverty. Taiwan and South Korea followed Japan along this path. Japan in the 1970s, Taiwan in the 1980s and South Korea in the 1990s made the transition now facing China from high-growth, export-driven economies toward a more moderately paced model driven and stabilized by middle-class purchasing power. Yet, all three were either democracies or had begun to undertake substantive political liberalization during these transitions. Can China’s authoritarian system absorb the shocks this transition is sure to produce? That too remains to be seen.
Then there are the unprecedented tests awaiting China’s leaders on the global stage. The nation’s economic interests are taking China’s government and state-owned companies into politically riskier countries. Meanwhile, a revolution in oil production and drilling techniques is attenuating U.S. dependence on oil from the Middle East. In fact, the United States has reduced its imports from OPEC countries by more than 20 percent just in the past three years and could become the world’s largest oil producer by 2020 and energy self-sufficient by 2035. China, on the other hand, is becoming more dependent on imports from countries like Saudi Arabia, Iran, Iraq, Libya, Sudan and Venezuela. Beijing has so far managed to maintain a policy of “noninterference” in the affairs of other countries, but as Washington becomes less willing to engage in the Middle East, China will find itself forced by its thirst for energy to take up the slack, involving Beijing in conflicts it has little experience managing.
Complicating matters further, although China has investment partners, it has no powerful allies—that is, governments that share Beijing’s political values and have the capacity to make a meaningful contribution to China’s security challenges. Even Russia, China’s frequent partner in UN Security Council obstruction, is unlikely to deepen its military ties with Beijing. The two sides continue to compete for influence in the Central Asian states that lie between them, and deep distrust of the other’s intentions remains the dominant sentiment in both militaries. Cooperating to thwart U.S. plans is easy. Working to change the international status quo is much more difficult. Nor can China count on an increase in its soft power to extend its influence. Mandarin Chinese is unlikely to replace English as the language of global popular culture, and China lacks the ideological appeal that once drew a large segment of the developing world toward the Soviet Union.
In a world where governments can’t afford to go it alone to protect their interests, China will struggle to build durable partnerships that extend its power.
WASHINGTON HAS settled on a smart approach to the unpredictability of China’s future, one that combines direct engagement of China’s leaders with a hedging strategy that deepens U.S. political, trade, investment and security ties with many of China’s neighbors. This is the aim of the “rebalancing” to Asia, a plan which explicitly recognizes the U.S. commitment to play a comprehensive long-term role in a region that can drive global growth over the next generation, but which will also face a number of developing security challenges without the institutional framework—no Asian Union, no Asian NATO—to effectively manage them. East Asia, in particular, is home to China, the emerging powerhouse, South Korea, a dynamic, developed country, and Japan, still a leader among industrialized nations. Yet, it is also the arena in which China’s rivalries with Japan, India and a number of Southeast Asian nations will play out—and where the North Korean wild card will continue to generate uncertainty and risk.
The rebalancing will continue the process of shifting a significant percentage of U.S. naval assets toward Asia, but a central component of this strategy is completion of the Trans-Pacific Partnership (TPP), an enormous trade deal involving more than a dozen Pacific Rim countries. Crucially, Japan’s new government, led by Prime Minister Shinzo Abe, has overcome traditional Japanese resistance to multinational agreements that pry open sensitive economic sectors to begin to negotiate membership. The U.S.-South Korean free-trade agreement entered into force last year.
Some in China see the TPP as an attempt to contain China’s expansion, and there is little chance that Beijing will push for early membership since the agreement would open areas of its economy that are not yet strong enough to withstand foreign competition. Even if President Xi does lead China toward the TPP faster than expected, the complexities of the multilateral negotiating process ensure that China won’t be able to join for some time to come. There is nothing in the TPP, however, that prevents members from forging trade and investment agreements with China or any other nonmember, allowing the United States to use it as a hedge against China’s growing regional power while leaving the door open for deeper engagement in the future. That’s the right balance.
Though the Obama administration has the right strategy, it has not given it the priority it deserves and is far too easily distracted by other issues, particularly in the Middle East. Washington can hardly afford to ignore developments in Syria, Egypt and other hot spots. The future of the euro zone will have far-reaching effects on the U.S. economy. Developments in Latin America are vitally important for U.S. security and prosperity. Yet, work on the rebalancing has barely begun, and opportunities to engage China directly have not received the energy and care they deserve.
America and China are the two largest economies, two leading trading nations and two biggest polluters. America is the world’s largest debtor nation, China the largest creditor. It is impossible to rebalance the global economy, slow climate change, meet emerging security threats, and promote peace and prosperity in Asia without as much cooperation as possible between the leading established and emerging powers. This work is in the interests of both countries and both governments.
Presidents Barack Obama and Xi Jinping have a lot to talk about. The future of the largest bilateral trade relationship in history, the potential for security cooperation for mutual benefit, the future of the Korean Peninsula, containment of conflicts in cyberspace, opportunities for joint development of energy-efficient technologies as a means to stoke economic growth and combat climate change, and a hundred other subjects should fill the early agenda. And make no mistake: it is the presidents themselves who should lead this effort to give it the urgent attention it deserves.
It is easy enough to list the ways in which U.S. and Chinese interests differ. China’s leaders will not accept international responsibilities that compromise their ability to maintain stability at home. They will continue to allow the Chinese currency to appreciate at a pace designed to protect China’s development, not one intended to help Washington balance its books. They will not accept criticism of their human-rights policies or of their approach to Taiwan or Tibet.
For their part, U.S. leaders will continue to press China to accept more responsibility for helping to manage security threats that weigh on both the U.S. and Chinese economies. They will continue to insist that China protect intellectual-property rights, abide by trade and investment rules, and work to resolve territorial disputes with its neighbors that might flare out of control. And U.S. officials will continue to insist that China grant its citizens greater freedoms, even if they know that Beijing will resist.
These sources of disagreement are obvious, but they should not prevent the two governments from improving their relations wherever possible. Failure to make progress in one area should not slow work on another. In today’s world, much will depend on the willingness and ability of America and China to work together wherever they can—for their own benefit and for the world’s.
Ian Bremmer is the president of the Eurasia Group, global research professor at New York University and a contributing editor at The National Interest.
