Transitions amidst Troubled Waters

Remarks to China Renaissance Capital Investors

It’s an honor and pleasure to be with you once again in this very different part of China.  You wouldn’t know it to look at Macau’s malls, hotels, and casinos, but this is where contact between China and the modernizing West began.  The arrival here of Jorge Álvares in May 1513 began a complex five-century-long interaction that took many painful twists and unexpected turns but led eventually to China’s modernization and integration into a globalized economy.  This history has culminated — for better or ill — in the transformation of this sleepy ex-Portuguese colony into a sleepless citadel of avaricious hedonism.  It’s always an adventure to be back here.

As it was in 1513, the Indo-Pacific region is once more the world’s economic center of gravity and, thanks to supply chain economics, China is again its focal point.  The Indo-Pacific — including ASEAN, China, India, Japan and Korea — now accounts for about 29 percent of world GDP, larger than the Europe Union’s 25 percent share or America’s 21.5 percent.  China alone contributed one-third of global economic growth last year.

This is the most dynamic region in the world in more than commercial terms.  For the first time in centuries, defense spending by the Indo-Pacific countries exceeds that of Europe, though both continue to be dwarfed by the United States.  The world’s arms merchants are full of optimism about their prospects in Asia.  The one thing this region has not come up with is a political system that others find worthy of emulation.  In that arena, the United States has recently compromised both its freedoms and its reputation.  Western Europeans now have the only political models with global attractive power.

Perhaps as early as 2016 or ‘17 the size of China’s economy will overtake America’s in terms of purchasing power parity.  A few years later, it will be larger at nominal exchange rates.  For the first time since about 1880, the United States will not have the largest economy in the world.  For the first time since the 1840s, the top position will be occupied by China.  The concept of “emerging markets” has lost its original meaning.  There is now a global market.  Every national economy is tied to it.  In it, China is the emerging heavyweight.  And problems that affect the political economy of the Indo-Pacific inevitably become problems for the world.

Majorities in most countries already see China as the world’s “leading economic power.”  That’s premature and a misperception of both China’s capabilities and intentions.  In recent decades, China has advanced a century every fifteen years.  It is a major commercial and financial actor.  It is not yet a politico-economic leader at either the regional or global level.  Still, the expectation that China will lead has major political consequences.  How much longer will it adhere to Deng Xiaoping’s advice to avoid the limelight and focus on capacity-building?  Not long, I’d guess.

China’s economy is now a huge factor in global manufacturing, trade, and the consumption of raw materials but its service and financial sectors remain underdeveloped.  Its role in international monetary affairs is constrained by the incomplete internationalization of its currency.  Despite China’s economic achievements, it has not sought or been accorded a role in  international organizations and policy-setting fora commensurate with its growing weight in global affairs.  Still, where governments lag, the market leads.  The world’s traders and investors recognize that what happens in and around China to some extent now affects every country in the world.  China is now a world power in economic-commercial, if not in other, terms.

Given China’s growing economic heft, Beijing will be unable forever to evade the demands of domestic constituencies that it throw at least some of its weight around and push the global political-economic system in directions Chinese businesses find more congenial.  Most Chinese judge that deferential policies intended to mollify their country’s neighbors and the United States have not been reciprocated and have failed.  There are indications that the new leadership about to take charge in Beijing feels the pressure and intends to take a somewhat more forceful role on the global stage than in the past.  The 18th congress of the Chinese Communist Party kicks off in just six days.  China’s new government will be entirely in place next March.  A year from now, when the Party convenes its third plenum, China will have defined the course it will take in the coming decade.  Events between now and then will help determine what that course is.

Just four days from now we Americans will elect our next president.  This is the first time in history that both China and the United States have selected leaders at the same time.  Such twinned transitions inject uncertainty into the relationship between the two countries.  (Another such coincidence won’t occur till 2032.)

During the campaign in the U.S., there has been a lot of China-bashing by both presidential candidates, reflecting frictions borne of the remarkable economic, monetary, and financial interdependence between the United States and China as well as the propensity of Americans, like the citizens of other countries, to blame our frustrations on foreigners.  American frustrations are now considerable.  There are many elements to them but for the most part they derive from an economy that is essentially flat-lined by uncertainties about government spending and tax policy, deteriorating human and physical infrastructure, and the crushing costs of America’s military misadventures in West Asia.  Chinese too have their frustrations — about the maldistribution of income, corruption, environmental degradation, and the bogging down of the reform process, for example.  The need to cure a daunting accumulation of domestic socio-economic and political problems is the main driver of policies in both countries, not a fixation by Americans on China or vice versa.

This American election will not cure partisan gridlock in the United States.  It may well exacerbate it.  2012 will end in Washington with a partisan struggle on the edge of the “fiscal cliff.”  Only after this political cliffhanger will the president-elect be able to form an administration, nursing his bruises from the fight as he turns his attention to longer-term problems.  The national mood in America is more likely to be fractious than ebullient.

If Governor Romney is elected, his campaign promises foretell a tenser U.S. relationship with China at least for a time.  He has said that, on his first day in office, he will label China a “currency manipulator.”  This will surely provoke a strong riposte from a new Chinese leadership that cannot afford to appear weak either to its own people or to the new American administration.  Romney’s promise to sell advanced fighter jets to Taiwan risks escalating Sino-American politico-military confrontation.  An actual sale could reignite military tensions in the Taiwan Strait, which are now at an historic low.

If President Obama is reelected, he will face continuing pressure from his own party as well as congressional Republicans to resist the impact on America of the changes in the economic balance of power that China’s rise is bringing about.  That too will make the management of bilateral relations more difficult, especially given the feisty nationalism that increasingly dominates Chinese politics.

Either way, when the next American president takes office on the 20th of January, a less conciliatory leadership in Beijing will be dealing with a less accommodating leadership in Washington.  The consequences of this are bound to be a less stable and cooperative Sino-American relationship on bilateral, regional, and global matters.  This will have consequences for the countries of this region as well as those farther afield.  The Indo-Pacific is now the engine that propels the growth of the global economy.  If quarrels between its constituent nations and between them and their major trading partners depress its peaceful development, the entire world will feel the impact.

Regional interactions between the  United States and China are now difficult due to the eruption of long dormant territorial disputes over islets, rocks, and reefs in the East and South China Seas.  These disputes pit China against U.S. allies and security partners.  In the case of the Diaoyu Dao / Senkaku issue, they revive unwelcome memories of an unrepentant Japan’s militarism and the many cruelties it visited on the Asia-Pacific region.  They challenge the credibility of U.S. defense commitments.  These disputes also raise questions about the prospects for economic cooperation among key actors who are now at the center of the global economy. They cast doubt on prospects for Sino-American cooperation on issues of global governance.  Without economic cooperation among Asian nations, global growth may falter.  Without Sino-American cooperation, many issues affecting the world’s socio-economic conditions cannot be managed, let alone resolved.

China needs peace along its borders in order to pursue its national priority of economic and social development.  In the American view, absent an American presence along those borders, frictions between a rising China and its neighbors over historical issues might long since have exploded into conflict.  China’s implicit acknowledgment of this risk, particularly with Japan, accounts for its four-decade-long acceptance of the U.S. as an essential part of the regional security architecture.

China has no expectation that it can or will have a military free hand off its shores no matter how great a navy it builds.  China is bordered by fourteen other countries, many of which are great powers with a history of conflict with it.  India, Japan and Russia fall into this category, as does the United States, whose 7th Fleet patrols China’s twelve-mile limits.  Other neighbors, including Korea, Pakistan and Vietnam are significant military powers with their own difficult histories with China.  China has plenty of reasons for the risk-averse approach to territorial disputes and military interaction with its neighbors it has traditionally pursued. The greater American emphasis on Asia promised through “rebalancing” supplements an existing balance.  It does not create a balance where none has existed.  There is no power vacuum around China with or without the United States.  There is a complex balance of power that is evolving along with China.

Contrary to the view of many, China’s rise is also far from the sole driver of the recent contention over maritime boundary disputes.   There is no power vacuum on China’s maritime periphery for America or any other external actor to fill.  Quite the contrary.  The new prominence of previously obscure territorial claims in the East and South China Seas was catalyzed by the entry into force of the UN Convention on the Law of the Sea and by the desire of the various claimants to secure ocean and seabed resources.  But the resulting contest over who should control these resources reflects expanded naval, fisheries, offshore oil, and related capabilities on the part of China’s neighbors as much as it does parallel enhancements of Chinese power.  China and its neighbors are reacting to each other’s increased presences in the spaces between them.

The result has been the aggravation of disputes over territory.  Such disputes now trouble China’s relations with Japan, the Philippines, and Vietnam as well as India.  As tensions have risen, Asian apprehensions about growing Chinese military power have become acute.  In its self-appointed role as the benevolent overseer and lubricator of regional relationships and balances, the United States is responding to these apprehensions.  As U.S. policy shifts to countering Chinese influence, Chinese views of the American presence in the region are also changing for the worse.

It is entirely natural that Asian countries should wish to invoke the United States to balance China’s rising strength.  They understand that they must accommodate China’s power but they wish, understandably, to do so gradually and in ways that do not compromise their independence, impair their dignity, or sacrifice their sovereignty.  In this context, America is an obvious counterweight to the emergence of a Chinese-dominated order in the Indo-Pacific.

America has long been accepted as a big factor in the evolution of the Indo-Pacific region’s geopolitics and political economy.  The arrival of a U.S. naval squadron in Tokyo harbor in 1853 set in motion events that produced the modernization and rise of Japan as a great power.  The United States itself became a Pacific power in 1898, when it conquered and colonized Guam and the Philippines.  That was 114 years ago.

In 1945, the United States defeated the Japanese attempt to dislodge it and supplanted both Japanese and European imperialism as the dominant force in the Indo-Pacific region.  Since then, the United States has successfully excluded other great powers from participation in the management of the region’s affairs.  No nation has challenged the legitimacy of American primacy since 1972, when America abandoned its blockade of China and began to help it become a full participant in the management of global, if not regional, affairs.  The question now is whether the United States will accommodate or attempt to resist a role for Chinese power in the affairs of the Indo-Pacific.

Amidst the global ascendancy of Indo-Pacific economies and intraregional angst about Chinese hegemony, a U.S. policy of “rebalancing” to emphasize Asia makes perfect sense.  It has the potential to stabilize the region in ways that benefit all within it, including China.  But how such a policy is conceived and implemented makes all the difference.

Most Asian countries have benefitted from the six-decade-long Pax Americana in the Indo-Pacific but it does not follow that they will accept a continuing American monopoly of influence in their region.  Rather, since their interest is in independence, not subordination to any foreign power, almost all would prefer to offset and balance growing ties with China with diversified relationships that can sustain their freedom of maneuver.  To this end, some have begun to explore coalitions of mutual support even as they enhance their relations with America.  The expanding security dialogue and cooperation between India, Japan, and Vietnam are cases in point.  So is Indonesia’s development of military ties with both China and the United States.

The prospect of Chinese hegemony frightens China’s neighbors, but none of them wants to become a foot soldier in a Sino-American or Sino-Indian battle for strategic primacy in their region.  What they seek is a modus vivendi with China and entente with America — understandings about limited cooperation for limited purposes in limited circumstances — not rigid or entangling alliances.

China’s truculent reaction to more assertive approaches by the Philippines and Vietnam to their claims in the South China Sea has been singularly maladroit.  It has scared even some in the region who do not contest territory with China.  But the United States stepped forward to reassure ASEAN claimants of its concern for their security without addressing the fact that they have claims against each other as well as against China.  This one-sided approach helped to embolden some in the region to up the ante with Beijing.  This, in turn, helped to infuriate China.

The unfortunate net effect of the American attempt to contain and calm these quarrels has been to inflame nationalist passions on all sides and to aggravate, not mitigate their disputes.  The relevance of the United States to the peaceful resolution of disputes has not been demonstrated.  The atmosphere has become much less rather than more favorable to compromise.  This is certainly not what the United States intended.  It is counter to U.S. interests as well as to those of all parties to these disputes, not just China.  But it is a fact.

The U.S. decision to interpose itself between China and other claimants has had other unintended consequences.  These include a split in ASEAN and the apparent beginning of a division of Asia into American and Chinese spheres of influence.  Military confrontation between the United States and China, once limited to the Taiwan Strait, now extends to the entire region.  By making trivial territorial disputes in which it has no intrinsic interest a centerpiece of U.S.-China military antagonism, the United States has not just dimmed prospects for the peaceful resolution of these disputes, it has multiplied the number of issues that could spark a Sino-American war. By injecting a great power element to what had previously been purely local contentions it has also raised the stakes for Chinese nationalists agitated about the claims of others to territory and adjacent waters in the South and East China Seas.

In a long-term contest of the kind that seems to have been set in motion, China has the advantage if it’s prepared to accept the protracted resentment of its neighbors and reduced cooperation with them.  China’s relative size, wealth, and power are likely in time to enable it in most cases eventually to prevail over other, smaller and less powerful claimants.  Until that happens or all concerned agree to let every country keep what it has seized in recent decades, however, frictions over disputed islands and economic zones will take their toll on China’s bilateral relations with its Southeast Asian neighbors, while impeding the exploitation of maritime resources by all parties.

These frictions will also inhibit further progress toward economic integration in the region.  A slowdown in this process or its reversal cannot help but have broad effects on the global economy.  It is sad to have to contemplate a world in which regional peace and global prosperity are hostage to the disposition of barren islands inhabited only by birds and goats.  Yet the march of folly the disputes over these islands has initiated has the potential to derail the peaceful development of Asia and perhaps the world.

In Northeast Asia, Japan’s dispute with China over the Senkaku / Diaoyu archipelago has already depressed trade, tourism, business travel, and investment between the two countries.  A parallel Japanese dispute with Korea over Dokdo / Takeshima has had a similar but less dramatic effect on Japan’s economic cooperation with South Korea.  None of the parties to these disputes has distinguished itself in its handling of their domestic political or diplomatic aspects.  At present, South Korea denies that there is any dispute over Dokdo while Japan similarly denies that there is any dispute about sovereignty over the Senkaku archipelago.  There is dialogue but no negotiation between the parties.

In the case of the Senkaku / Diaoyu Dao issue, the peace has been shattered by Japanese actions and Chinese reactions.  Hardening attitudes in each nation toward the other preclude either the reconstitution of the status quo ante or resolution of the territorial dispute.  Some way must now be found to bring the current paramilitary struggle in the area to an end, assure that it is demilitarized, and manage Sino-Japanese differences over it for the long term.

It is hard to imagine how further progress toward financial and economic integration can take place unless these newly contentious territorial issues are once again shelved.  And it is hard to see how this can happen when the rival claimants dispute the reality that there are disputes that must be managed rather than exploring how to manage them.  Despite American aspirations for continued leadership of the region, the United States has essentially wrung its hands while sitting on them as these quarrels have unfolded.  American advice to the contending parties has been anodyne.  No one seems to be paying any attention to it.  There are differing views everywhere about whether the United States is part of the solution or part of the problem.

Japan is America’s most important ally in Asia.  Japan counts on U.S. support should it stumble into war with China, North Korea or Russia.  The United States has urged Japan to engage China in dialogue about the Senkaku issue.  Yet members of both the Japanese cabinet and the political opposition have chosen this moment to bear witness to defiant nationalism by visiting the Yasukuni Shrine, which symbolizes Japan’s lack of remorse for its bestial treatment of Chinese, Koreans, and others in World War II.  This reminder of past events further inflames nationalist passions on all sides.

Though very few Chinese or Japanese want war, armed conflict between them is no longer unimaginable.  That means that conflict between China and America is more likely than it was.  It also means that Japan is picking its own fights with China but counting on the United States to back it if its stance leads to conflict.  The new administrations in both Beijing and Washington will inherit this unwelcome possibility and have to deal with it.

In sum, as 2012 draws to an end, politico-military crises in the South and East China Seas threaten the continued peace and development of the Indo-Pacific region.  The heart of the world’s economic center of gravity is in a state of fibrillation.  Rising tensions between China and key actors in both Southeast and Northeast Asia as well as the United States will make it more difficult for all concerned to deal effectively with  the economic and other challenges they face.

These challenges are not small.  They go beyond regional issues to include reform of the world’s monetary and financial systems; action to mitigate and, if possible, remediate global climate change; and necessary adjustments in the trade, investment, and intellectual property regimes that regulate global capitalism.  The way the various claimants manage essentially trivial territorial disputes may end up deciding whether the 21st Century will be guided by cooperation or conflict between China and other regional and global great powers.

The uncivilized behavior of the Chinese mobs who smashed and looted Japanese businesses and products has raised questions abroad about how much ordinary Chinese have adjusted to their new status as central participants in world affairs.  Curbing intemperate xenophobia is, however, merely one of many aspects of the adjustments that constitute modernization.

Nine years ago, in 2003, Severe Acute Respiratory Syndrome (SARS) struck south China and nearly became pandemic.  An initial Chinese cover-up of the situation helped to spread panic both in China and abroad.  China learned from that experience and took corrective action.  But just a couple of months ago, amidst the uncertainties of the Bo Xilai incident and the succession process, China’s heir apparent, Xi Jinping, dropped out of sight.  There was and has been no official explanation for his disappearance.  Just imagine the chaos that such enigmatic behavior would cause in global currency markets if it were repeated after the Chinese yuan becomes a fully convertible reserve currency!  It is hard to avoid the conclusion that China is still some way from ready for the responsibilities its wealth and power are inevitably conferring on it.

China’s rapidly increasing role in world affairs requires it to modernize its politics and information policies.  Traditional Chinese reticence is incompatible with the stable international environment that China needs for its prosperity and international trading and investment relationships.  China’s size and development ensure that — even if it wants to — China can no longer get away with hiding its light while building its capacities but exercising them sparingly to solve problems with neighbors.

For the Chinese leaders about to take office, the crises along China’s maritime frontiers and in relations with the United States must appear as a painful distraction from more pressing domestic tasks.  These tasks include political and economic reforms to assure greater income equality; a better balance of benefits between the cities and the countryside; less abuse of official privilege; fairer management of land, water, and environmental issues; a reformulated balance between social order and freedom of speech; greater transparency in government decision-making; the revitalization of finance for small and medium-sized enterprises; and better corporate governance.  The economic model that has powered Chinese growth for the past three decades has exceeded its useful life and must be changed.  So too must elements of China’s political system and the way it relates to the outside world.

Almost 93 percent of Chinese over the age of fifteen are now literate.  The number of internet users in China is set to surpass 700 million next year.  The Chinese people expect more of government and key institutions in their country; they are not afraid to say so.  Some in the Communist Party understand that the mechanisms for citizen participation in the governance of Chinese society must evolve to accommodate this reality.  Some do not.  Some favor a continued low profile for China internationally.  Many more Chinese now believe that their neighbors took advantage of China’s decision to defer pressing longstanding maritime claims by inventing their own claims and creating facts to support them.  Growing numbers would like to see China use its new strength, including its military power, to deal with foreign policy problems.  Still, virtually all Chinese continue to accept the importance of putting domestic modernization ahead of muscular engagement in foreign affairs.

The United States, too, needs a peaceful international environment in which to recover from the damage done by irresponsible fiscal policies, partisan gridlock, and the neglect of domestic priorities in favor of spending on foreign wars.  Americans now want to turn their attention to nation-building at home.  Most want to lighten, not deepen, the burden of foreign commitments. Most want fair and peaceful competition with China, not military rivalry or antagonism.  Without getting into the question of whether the American vision of the United States role in Asia is reasonable or even feasible, this lack of any desire to go to war with China over the claims of allies to obscure islands in the middle of nowhere surely reflects a consensus view.

It has become a commonplace to observe that the relationship between the United States and the People’s Republic of China constitutes the most consequential bilateral interaction of our times.  Despite current and projected tensions, the shared interests of America and China in sustaining good relations are as strong as ever.  There is therefore every reason to hope that Sino-American competition can continue to be conducted to mutual advantage rather than destructively and that cooperation can be further enhanced.

Whether this hope is realized will depend in large measure on the vision and statesmanship of the leaders that the two counties select next Tuesday and Thursday.  It matters greatly not just to Americans and Chinese but to the peoples of the region and world that the new leaders of the United States and China should have the vision and wisdom to work effectively with each other to manage differences.  What happens in the first half of 2013 could very well determine the future of both countries and the course of world affairs for decades to come.

Ambassador Chas W. Freeman, Jr. (USFS, Ret.)

Macau S.A.R., China

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