June 2017 Vol. 21 No. 2 Economic Quarterly - cebc.org.br 2017 Vol. 21 No. 2 The Dawn Of Pax Sinica? ... technology and management. ... Easternization:

China In The Asia-PacificBossing the neighborhood

June 2017Vol. 21 No. 2

The Dawn Of Pax Sinica?Not Just Yet

ExportsInching up the value chain

Hong KongTwenty years of missed opportunities

ChinaEconomicQuarterly

GavekalDragonomics

www.gavekal.com

The Party Line

US-China Power Shift: Not So Fast 3 By Arthur Kroeber

China In The Asia-Pacific

The Belt And Road To Leadership 9 With the Belt and Road making progress and the TPP dead, China hopes to become the new driver of Asian integration. By Tom Miller

After The Pivot, It’s Bye-Bye Asia 17 Striking a grand bargain with China might prove too hard, even for Trump. A gradual US retreat from Asia is more likely. By Hugh White

High-Speed Rail Blues 24 Exporting high-speed lines is easier said than done, as China is learning at its expense in Indonesia. By Agatha Kratz

Economy

The Regulatory Storm 31 Regulators are fighting to tackle risks in the financial sector. Whether the measures work depends on their implementation. By Chen Long

Vol. 21 No. 2 June 2017

China Economic Quarterly

Trade

The Export Upgrade Challenge 37 China is slowly climbing up the export value chain, but it still relies heavily on foreign input, technology and management. By Arthur Kroeber and Dan Wang

Politics

Still Holding High Mao’s Banner 48 Today, China’s Neo-Maoists are Xi Jinping’s best allies; tomorrow, they could become his fiercest opponents. By Jude Blanchette

Society

Whatever Happened To Hong Kong? 54 Twenty years after joining China, Hong Kong’s star has faded. But don’t bet against the city just yet. By Simon Cartledge

Books

The East Is Rising … Isn’t It? 61 The conventional wisdom that Asia’s rise means America’s decline is both right and wrong. By Tom Miller

EditorArthur Kroeber

Managing EditorTom Miller

Assistant editorAgatha Kratz

Design & productionBig Brains

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3 China Economic Quarterly, June 2017

Do Donald Trump’s miscues ensure the eclipse of Pax Americana by a rising China? Not yet.

As Donald Trump drives the US further into a confused, braggadocious isolationism, one question is how swiftly China can fill the power vacuum that is emerging both globally and in its immediate Asian neighborhood. To answer it, we may divide Chinese power into four dimensions: polit-ical/diplomatic, economic, technological, and financial. This division enables us both to assess Chinese capacities and to understand which elements of China’s rising power actually matter for investors.

Diplomatic point-scoringOn the diplomatic front, China is taking full advantage of the blunders of the most incompetent administration in American history. Trump’s theatrical exits from the Trans-Pacific Partnership (TPP) and the Paris climate accord have enabled China to stake a claim as the main champion of global public goods. This claim is in part disingenuous. Xi Jinping’s stirring defense of free trade at Davos in January does not square with China’s heavily subsidized program of import substitution, onerous tech-nology-transfer requirements for foreign technology companies, and high barriers to entry for services firms. Its pledge to lead on reducing carbon emissions rings a bit hollow given its status as the world’s biggest emitter and largest builder and exporter of coal-fired power plants.

But China’s stance is also authentic, in material ways. It is an active par-ticipant in the biggest free trade agreement under negotiation in the world today—the Regional Comprehensive Economic Partnership (RCEP),

Arthur Kroeber is editor of the China Economic Quarterly.

The Party Line

US-China Power Shift: Not So Fast

By Arthur Kroeber

4 Gavekal Dragonomics

Arthur Kroeber

which includes 16 Asian countries accounting for 40% of global GDP. The Asian Infrastructure Investment Bank that it sponsored is the first signif-icant multilateral development lender since the founding of the European Bank for Reconstruction and Development. And while it’s fashionable to mock the clumsily named Belt and Road Initiative, China’s willingness to

finance better connectivity within Asia and between Asia and the rest of the world will almost certainly create positive economic spillovers.

On climate, China has made gigan-tic investments in renewable energy and nuclear power, pushed significant

gains in energy efficiency, and closed down many of its dirtiest power plants and coal mines. These efforts have contributed to what many researchers think may be a plateauing of China’s greenhouse gas emissions, more than a decade earlier than Beijing promised under the Paris agreement.

Despite these achievements and all the recent glad-handing between Chinese and European officials in response to Trump’s abandonment of US commitments, it is a stretch to think that an authoritarian and mercan-tilist China will exert much moral sway in Western democracies any time soon. But East Asia is a different story. That region increasingly sees the US as an unreliable partner and China as a more reliable one.

China has a natural advantage in this comparison both because it is the largest and most dynamic regional economy and because its strategic aims are limited while those of the US are diffuse. All China needs to do is incrementally increase its economic, political and military reach around its periphery year after year. The US by contrast is stuck defending, at great expense, a heterogeneous clump of legacy commitments, in a distant region, while doing the same in other parts of the world.

New strategy neededAs Hugh White points out later in this issue—and as FT foreign affairs columnist Gideon Rachman lucidly documents in his excellent new book Easternization: Asia’s Rise and America’s Decline—Washington must devise a strategy for accommodating China’s inevitably growing power without giving ground on US core interests, or abandoning allies. This is hard, since for starters it requires defining what is and is not a US core interest, rather than defaulting to the usual American position that everything is a core interest. For instance: is the preservation of Taiwan’s de facto inde-pendence a core US interest, or not? We can be reasonably certain that so

East Asia increasingly sees the US as an unreliable partner

and China as a more reliable one


The Party Line

long as Trump is president, no such thoughtful exercise will occur, and China will consolidate its influence in Asia.

How much impact does this shift in the political balance of power have in the economic sphere? In the short term, not much. Little evidence sug-gests that the business decisions of companies in Asia—how to organize supply chains, where to set up new production lines and sales offices—are governed by geopolitical considerations. Since both the US and China are interested more in commercial than territorial expansion, a gradual tran-sition from Pax Americana to Pax Sinica need not be disruptive.

The likelihood that a true Chinese-led regional order emerges depends on China’s ability to keep its economy growing at a rapid pace. Here there is room for doubt. As Andrew Batson has shown, (“Cyclically Fine, Structurally, Well…,” Gavekal Dragonomics, 3 May 2017), China’s current GDP growth rate is almost certainly unsustainable, and will probably fall to 5-6% within the next few years. Keeping growth near 5% in the 2020s will be tough, since productivity growth has been in steady decline for the past decade thanks to over-reliance on state-led investment. Restoring productivity will require a severe pruning of state enterprises, something Xi Jinping seems loathe to do. Eventually, a low-growth/high-debt “Japan trap” could be in China’s future—especially after 2025 when the impact of an aging and (by then) shrinking population will start to be felt.

But 2025 is a long way off, and until then it would be unwise to bet on a collapse in China’s trend growth rate. Despite the poor productivity trend, there are probably still significant gains left in capital deepening (especially through intensive investments in new technology); and we should probably not underestimate the cumulative impact of incremental improvements in capital allocation via the growing private sector, dereg-ulation of services, and fiscal reforms that are gradually subjecting local governments to harder budget constraints. A China growing even at 4% in the 2020s could pick up plenty of regional economic influence against a US growing at only half that rate.

A mixed record in technologyRelated to long-run growth potential is the third dimension we identified, China’s technological power. Here more than anywhere it is necessary to steer a sane middle course between two cartoonish views that receive far too much air time. One is that China is a technological juggernaut that will use virtually unlimited subsidies and ruthless extortion/theft/takeover of foreign technologies and technology firms to achieve global mastery in virtually every high-tech field. The other is that China is a


Arthur Kroeber

hapless copycat whose authoritarian political system will prevent it from ever developing an innovation economy.

Three observations should ground our assessment. First, China gener-ally remains technologically well behind the leading-edge nations (mainly the US, Germany and Japan), but it has a good track record of catching up to globally competitive levels faster than experts predict. And in some sectors where there is dynamic domestic demand, it has done a decent job of innovating (old economy example: metals smelting; new economy example: the internet and mobile payments).

Second, the fad for fetishizing “innovation” should not blind us to the fact that, thanks to its large internal market, China’s main comparative advantage is in the diffusion of technology, and diffusion is as important

to technological progress as innova-tion. China excels in taking estab-lished technologies, improving them a little and cutting their cost by a lot, thereby commoditizing them. Two prominent recent examples are wind turbines and solar panels, where

Chinese firms have established themselves as the dominant volume pro-ducers, but with very low margins. This is a meaningful achievement, but by definition it implies that technological leadership lies elsewhere.

Third, as my colleague Dan Wang and I point out later in this issue, China’s technological system remains uniquely entwined with global mar-kets. Foreign firms account for nearly three-quarters of China’s high-tech exports. And China remains far more dependent on licensing the rest of the world’s technology than vice-versa. For every dollar of tech licensing fees it pays out abroad, China extracts just five cents from the rest of the world in license fees for its own technology. The US earns three dollars for each dollar it pays out. In terms of licensing value, then, the US tech sec-tor is 60 times stronger than China’s. China’s tech sector is agile and well funded, but still has a lot of catching up to do. The symbiotic relationship between the Chinese and the Western tech ecosystems is likely to endure for some time.

Renminbi internationalization in the deep-freezeThe final power dimension—finance—is where uncertainty is great-est. On one end lies the plausible idea that financial fragility is China’s Achilles’ heel and the system is likely to be undone by an uncontrollable outflow of capital. On the other hand, there is the possibility that over the

China excels in taking established technologies, improving them a little and cutting their cost a lot


The Party Line

next decade the renminbi will emerge as a serious competitor to the US dollar as a global currency for financing trade and investment flows. For investors, this is the most relevant aspect of the US-China power rivalry.

The risk posed by capital outflows is substantial, and there is no better proof of this than the Chinese government’s aggressive recent efforts to shut them off. On the whole, though, fear of China running into a pay-ments crisis is overblown. Domestic savings are abundant (over 40% of GDP), there is a structural current account surplus, and selective capital controls are effective enough when they need to be.

Most important, Chinese citizens, rather like Japanese, have high confidence in their own system. They are not Venezuelans or Brazilians, who at the first hint of trouble will immediately shift all their assets into dollars. For sure, they have long been prevented from diversifying into foreign assets, and as this restriction is removed there will be a large stock adjustment while the private-sector financial portfolio adds a more appro-priate foreign-asset weighting. But there is no reason to think the Chinese authorities cannot manage this transition.

Equally, though, the drive to internationalize the renminbi seems to have stalled out. The inclusion of the unit in the IMF’s special drawing right basket in 2015 now seems like at least a temporary high-water mark. Since then, many indicators of international renminbi use have retreated. The share of Chinese trade settled in renminbi has slipped from 30% to 15%; direct investment transactions settled in renminbi have fallen to zero; offshore renminbi deposits have fallen by about 30% to roughly Rmb1trn; the renminbi’s share of international payments has stagnated at under 2% and has fallen below that of the Canadian dollar; and foreign institutional holdings of renminbi assets in China have fallen by about a third from their mid-2014 peak, to Rmb3trn. The renminbi accounts for a scant 1% of global central bank reserves.

Weak financial architectureThese trends reflect two factors. One is the market perception since mid-2014 that the currency was overvalued and would have to depreciate, perhaps quite a lot. The other is the evidence that Beijing will choose exchange-rate stability over full convertibility every time. In January 2016 the People’s Bank of China (PBOC) shut off liquidity to the renminbi market in Hong Kong in order to discourage currency short-selling; over the rest of the year it severely tightened controls on outbound remittances. Traders and investors will not make much use of a currency when neither liquidity nor repatriation of capital are assured.


Arthur Kroeber

Now that the exchange rate and capital flows have stabilized, will the push to globalize the renminbi resume? Maybe. There are two positive indicators. One is the enormous number of swap lines PBOC has opened with other central banks—33, with a total value of Rmb3.3trn (US$490bn) in 2015. (By contrast the Fed has five standing swap arrangements.) These swaps are structured more like credit lines than like the Fed’s emergency liquidity swaps. The scant available evidence, though, suggests that when these lines are tapped (for instance by Pakistan and Argentina in 2013 and 2014), it is not mainly to facilitate renminbi-denominated trade and investment but to plug short-term liquidity gaps until new US dollar funding can be arranged.

The other indicator is the imminent opening of the enormous Chi-nese domestic bond market to foreign investors, via the “Bond Connect” program set to launch in July, under which foreign institutions can invest via accounts in Hong Kong. The value proposition is tempting: Chinese bond yields are relatively high, and are likely to fall in the next few years as economic growth slows. A big rush by investors into Chinese bonds could signal a return of momentum for renminbi globalization. Yet on the whole, the weaknesses of China’s financial architecture militate against a shift away from the centrality of the US dollar, and of the New York/Lon-don based international financial system, within the next decade.

China rises, but America stays putAdding it all up, we conclude that China is scoring a lot of easy political points, and that sustained economic robustness between now and 2025 should enable it to keep funding rapid technological upgrading at home and infrastructure diplomacy abroad. Its credibility as a rising power will continue to grow, and it will weave an ever-tighter web of economic dependence around its neighbors in Asia. Strategic anxiety will mount in Washington. But the technological and financial underpinnings of the US-led system are resilient, and easy to underestimate. Even a leader as feckless as Trump will be hard-pressed to destroy them.


China’s Belt and Road Initiative elicits widespread skepticism and concern, while the Regional Comprehensive Economic Partnership is often seen as a poor cousin of the aborted Trans-Pacific Partnership. But they are currently

the only credible plans for greater Asian integration.

Skeptics will scoff, but China is on course to replace the United States as the leading power in Asia. China is still not trusted: the Belt and Road Initiative is stirring up as much fear as hope, and few countries buy its dip-lomatic mantra about delivering “mutual benefits.” Yet China’s economic diplomacy is bold, forward-looking and practical. No doubt it will deliver some costly boondoggles along the way, but the Belt and Road will also bring useful infrastructure, new trade routes and better connectivity to Asia and Europe. Following President Trump’s decision to withdraw the US from the Trans-Pacific Partnership (TPP), Beijing—not Washington and its allies—is now leading the charge for greater Asian integration.

Asian integration 2.0As America turns inwards, a newly self-confident China is attempting to replace it. Picking up from where he left off at Davos, Xi Jinping urged del-egates at May’s “Belt and Road Forum” in Beijing to reject protectionism and embrace globalization, implicitly under China’s leadership. Beijing’s PR machine is spinning the Belt and Road Initiative as “Globalization 2.0,” a more inclusive and equitable version driven by the East rather than the West. Much of this is bluster, but President Xi is playing a serious dip-

Tom Miller is managing editor of the China Economic Quarterly and author of China’s Asian Dream: Empire Building Along the New Silk Road (Zed Books, 2017).


The Belt And Road To Leadership

By Tom Miller


Tom Miller

lomatic game. Thirty heads of state attended the forum—not as many as Beijing hoped for, but a sufficient showing for Xi to present himself both at home and abroad as an international statesman of substance.

The Belt and Road Initiative is the first pillar of Beijing’s push to deep-en economic integration across Asia. China’s interests clearly come first, but few countries feel they can ignore its promise to deliver much-need-ed infrastructure. The Belt and Road Forum attracted top leaders from a majority of countries in Southeast and Central Asia, where much of China’s infrastructure diplomacy is focused. China’s leverage over its neighbors will inevitably grow as its economic grip strengthens, but that might be an acceptable trade-off for countries anxiously seeking econom-ic development.

The second pillar of China’s Asian integration push is the Regional Comprehensive Economic Partnership (RCEP), the only pan-Asian trade deal left on the table after the death of the TPP. While China has strug-gled to persuade the world that the Belt and Road is truly a cooperative enterprise, RCEP is officially led by the Association of Southeast Asian Nations (ASEAN) with strong support from Japan and Australia, both US allies. If a deal can be done—and the political will to make that happen is now high—it opens the door for China to expand its influence across Asia under a conveniently multilateral umbrella.

Defining the indefinableYet Beijing still has much to learn about effective international leader-ship. It is far better at inventing clunky slogans than actually explaining its intentions. Even after May’s forum, the Belt and Road remains poor-ly understood. The basic geographical parameters of the initiative are extremely broad, and therefore hard to define. On land, the “Silk Road Economic Belt” envisages new transport infrastructure and industrial cor-ridors stretching across Central Asia to the Middle East and Europe. On water, the “Maritime Silk Road” encompasses new ports and trade routes across the South China Sea into the South Pacific, and through the Indian Ocean to the Mediterranean Sea. Beijing talks about 65 or so countries belonging to the initiative, but there is no definitive list. It is tempting to conclude that it is now a shorthand for Chinese financing, investment and construction across the developing world.

The Belt and Road Initiative is less a coherent plan involving a clear list of infrastructure projects than a series of wide-ranging policy aims. It attempts a more strategic approach to overseas infrastructure construc-tion than in the past, but the success of individual projects will rely on the



vagaries of diplomatic negotiations and corporate deal-making. Another issue is bankability. President Xi announced at May’s forum that an extra US$55bn would be injected into China’s policy banks to help bankroll Belt and Road projects. China Development Bank and China Exim Bank must carry out state orders, but even their appetite for projects with no commercial viability is surely not without limit.

Given that building infrastructure and fostering new trade flows takes years, it is too early to assess whether the initiative is a success. Direct investments in the 60-plus countries along the Belt and Road were a whis-ker below US$30bn in 2015-16, according to the Ministry of Commerce. That barely amounted to 10% of overall outward direct investment—so the numbers are not huge by Chinese standards and do not look politically inflated. In March 2017, the head of the National Development and Reform Commission said that “more than US$50bn” had been invested since Presi-dent Xi proposed the initiative in late 2013, without giving details.

More substantively, there was a significant jump in 2016 in overseas construction contracts and revenues, which are not included in out-ward investment data. Mofcom reports that 61 Belt and Road countries generated new construction contracts worth US$126bn and revenues of US$76bn, accounting for about half of China’s total for both. These figures need to be treated with caution: there is a high probability that the con-tracted revenues are inflated to some degree by state-owned enterprises


Tom Miller

and officials looking to hit political targets. Moreover, not all of these projects are necessarily related to the Belt and Road’s core infrastructure push. Even so, the data are encouraging for engineering firms seeking new markets outside China, and do suggest the initiative is gaining traction.

Much of this construction was planned or already underway before President Xi repackaged it under the Belt and Road moniker—yet that does not mean the initiative is phony. Take the New Eurasian Land Bridge, a series of roads and railway lines from China to Europe. Kazakhstan began building a railway linking China to Russia back in 2004, and the first rail services to Duisburg in Germany began in 2012, a full year before President Xi first spoke of building a new Silk Road. But his political support has added considerable momentum to the project. The number of transcontinental services rose to 40 by the end of 2016, connecting 16 cities in China with 15 cities in Europe in as little as 10 days. More than 1,700 freight trains left China for Europe last year, double the total in 2015. Further services are planned.

Accessing AsiaIn South Asia, the China-Pakistan Economic Corridor—a US$50bn rag-bag of infrastructure and agricultural projects that includes a planned highway, railway and pipeline linking landlocked western China to the Arabian Sea—is making headway. Gwadar Port, the gateway to the cor-ridor, opened in November 2016 after upgrades worth US$1.6bn. China began work there as far back as 2002, completing the first phase of a deep-water port in 2007. Still, the Belt and Road Initiative has provided extra cash and linked the project to the more ambitious economic corri-dor. China Overseas Port Holding Co plans to spend US$4.5bn on roads, power, hotels and other infrastructure in Gwadar’s industrial zone. The Pakistan Stock Exchange soared by 40% in the year to May, buoyed by the promise of Chinese-led investment.

Over the past year, projects to improve connectivity across Southeast Asia have also progressed. One example is an alliance between 10 Chi-nese ports and six Malaysian ports, which are working together to reduce bottlenecks and boost trade; China is investing US$10bn in a deep-sea port and commercial marina in Malacca. Up the coast, China Commu-nications Construction Co has begun work on a 620-km rail line from Kuala Lumpur to the Thai border, with a US$12bn loan from China Exim Bank. This will link to a US$7.2bn railway across Laos, which Chinese engineers are carving through the jungle. Across the Malacca Strait, pre-paratory works have begun on the Jakarta-Bandung high-speed rail under



a consortium of state-owned Chinese and Indonesian contractors, with US$4.2bn funding from China Development Bank.

Beyond Asia, Chinese engineers have upgraded the railway line from Nairobi to the port of Mombasa on Africa’s east coast, while China will soon open its first overseas military base in Djibouti. In the Mediterra-nean, China Ocean Shipping Company (Cosco) has invested €4.3bn on a 35-year management lease at Greece’s Piraeus port. Container through-put nearly quadrupled under its management in 2010-15, with Huawei, ZTE, Samsung, HP and Sony using Piraeus as their gateway to Europe. In August 2016, Cosco obtained a majority stake in the port, committing to invest a further €700mn over the coming decade. It aims to make Piraeus the biggest commercial port in the Mediterranean, eventually competing with Hamburg, Rotterdam and Antwerp.

Skepticism—necessary but not sufficient Despite all this, doubts hang over the viability of many Belt and Road projects, for a variety of reasons. One issue is security in politically vol-atile states. Pakistan has reportedly deployed 14,500 security personnel to ensure the safety of some 7,000 Chinese nationals working on the economic corridor. The danger was evident in May, when two Chinese language teachers were kidnapped by armed men in Quetta, a remote but important section of the corridor.

Another issue is commercial viability. Freight trains from China to Europe may not prove profitable, however much time they save, while critics fear that new railways through Laos and Thailand will not deliver

Along the Belt and Road

Sample Chinese-funded projects associated with the Belt and Road Initiative

Cost,Project Location US$ bn ContractorVientiane-Boten Railway Laos 7.2 China RailwayAmur Bridge Russia 0.4 China RailwayZarbino Port Russia 3.0 China MerchantsKarakoram Highway Phase II Pakistan 1.3 CCCCGwadar Port East Bay Expressway Pakistan 0.1 UnknownPeshawar-Karachi Motorway Pakistan 2.8 CSCEEast Coast Rail Line Malaysia 13.1 CCCCNational Road 55 Cambodia 0.1 China Road & BridgeHambantota Port Phase II Sri Lanka 0.8 CCCC

CSIS


Tom Miller

the economic benefits Beijing promises. The high-speed rail line in Indo-nesia is also suffering from expensive delays.

Critics of the Belt and Road Initiative have begun to refer dismis-sively to “One Belt, One Trap.” Executives in some Chinese banks and construction firms privately complain they are under pressure to deliver projects that will never make a decent return. Meanwhile, opposition to Chinese investment abroad is deepening, stirred by fear that Chinese loans-for-infrastructure really amount to an inescapable debt trap. In Sri Lanka the new government has tried in vain to extricate itself from a series of high-interest loans negotiated by the corrupt regime of Mahinda Rajapaksa, who was ousted in January 2015. Failing to find alternative sources of financing and investment, Colombo has turned back to Beijing. It is swapping debt for equity in Chinese-financed infrastructure projects to pay back some of the US$8bn it owes.

The Belt and Road will continue to elicit fear and skepticism. India, condemning the initiative as a strategic ploy, has refused to come on

board. Yet much of this anxiety is overdone: for all its faults, the initia-tive is a concrete and useful attempt to boost regional development and integration. No other country has come close to articulating such an ambitious plan, and no other country could finance one. This is

important, because trade growth in the Asia-Pacific is slowing, having fallen below GDP growth since 2012. That may partly reflect a consoli-dation of production chains in China, which pushed down intraregional trade in intermediate goods. But better connectivity provided by China could begin to reshape those regional supply chains by creating newly viable manufacturing bases. This should be positive for developing Asia.

A noodle bowl of acronymsThe next step for China as it attempts to boost regional integration is to push for the adoption of RCEP. The TPP—a free trade and investment agreement encompassing a dozen nations, effectively led by the US—promised to bring a large chunk of the Asia-Pacific closer together. But it pointedly did not include China, in addition to such other large Asian economies as India, South Korea and Indonesia. RCEP, by contrast, includes all 10 ASEAN member states and the six countries with which they have free-trade agreements (FTAs): China, Japan, South Korea, Aus-

The Belt and Road Initiative is a concrete and useful attempt to

boost regional development and integration



tralia, New Zealand and India. With its prospective members accounting for 40% of global GDP, RCEP’s market size is much larger than the total market size of the Asian countries in the now defunct TPP.

The death of the TPP was a big blow to the seven Asian nations involved, which remain hungry for trade even as the US and Europe flirt with protectionism. Once viewed as an also-ran, RCEP is now seen as a necessary alternative. “The RCEP is key to stopping the protectionist tide,” Hiroshige Seko, Japan’s minister of economy, trade and industry said in April 2017. “With the TPP gone,” added Malaysian prime minister Najib Razak, “it is more relevant now than before.” The toughest task will be finding common ground among the three largest economies: China, Japan and India. But if a final deal can be struck, the strong political will to deepen trade ties means RCEP stands a decent chance of being ratified by national parliaments.

If that happens, RCEP should be a boon for Asia. It promises to sup-port trade growth and regional manufacturing by eliminating trade tariffs within the regional supply chain. It would also untangle a noodle bowl of trade agreements: by 2015, there were 18 bilateral FTAs among East Asian states, in addition to various regional agreements. RCEP should prove especially beneficial to members with no current bilateral FTAs: China and India, Japan and Korea, and Korea and India. Negotiations are at an advanced stage: launched in 2013, RCEP had already seen 16 rounds of talks by the end of 2016. Two previous deadlines have been missed, but there is considerable pressure to conclude an agreement either by the end of this year or early in 2018.

Who can stop China?RCEP’s success is a litmus test of Asian commitment to closer cooperation and greater regional institutionalization. The biggest stumbling block is likely to be India: while other nations focus on lowering tariffs on goods, New Delhi fears a flood of cheap imports. Instead it is pushing for a liber-alization of services and greater freedom of labor, which other countries in turn fear could presage a flood of Indian migrant workers. So India could be left out of any initial deal.

That would hardly dismay Beijing, which quietly views RCEP as anoth-er means of strengthening its sphere of influence in Asia. Beijing’s rela-tionship with New Delhi is as awkward as it is with Tokyo, and India could prove a difficult partner. Indian intransigence is already an obstacle to the success of the Belt and Road in South Asia. New Delhi objects to the Chi-na-Pakistan Economic Corridor, which runs through territory claimed by


Tom Miller

India in Pakistan-occupied Kashmir and Gilgit-Baltistan. Prime Minister Modi, who turned down an invitation to attend the Belt and Road Forum, has implicitly criticized China’s connectivity projects for “overriding [the] sovereignty” of other nations.

As a clearly multilateral initiative, RCEP is less politically fraught for Beijing than the Belt and Road. For all its talk of “interconnected devel-opment” and “international cooperation,” many countries still fear that China’s infrastructure diplomacy is really a ruse for its own economic and geopolitical advancement. There are also valid doubts over the economic benefits that some Chinese-led projects will bring. But as the US with-draws from its international obligations, an alternative power is needed to provide regional public goods. And as the principle engine of economic activity in Asia, China will play the leading role in shaping regional inte-gration. It is difficult to see how Washington, or anyone else, can compete.


With the costs and risks of confronting China growing by the day, the most likely scenario for the Asia-Pacific is one of steadily dwindling US influence. This is good news for

Beijing and its claim to regional leadership.

We can no longer take for granted the peace and stability that has done so much to underpin Asia’s economic success. Of late most concern has focused on North Korea, but the issues are bigger than that. The whole regional order, which for decades has been based on uncontested US stra-tegic leadership, is under pressure because China is challenging America’s position as the region’s leading power. Ultimately there are only three ways this can play out, depending on how the US responds to China’s challenge:

1. The US could push back decisively, going all out to reassert its leader-ship and preserve the old order which has kept Asia stable for so long.

2. It could try to reach an accommodation with China, making room for Beijing to play a bigger role in regional affairs and accepting that its own role will diminish, but still retaining a strategic presence strong enough to constrain Chinese power.

3 It could concede to China’s challenge and withdraw strategically from Asia, leaving other countries to decide for themselves how far to accept China’s regional leadership and how far to resist it.

Until quite recently it was easy to assume that option one was most

probable—but doubts were growing even before Donald Trump’s election,

Hugh White is Professor of Strategic Studies at Australian National University and author of The China Choice: Why We Should Share Power (Oxford, 2012).


After The Pivot, It’s Bye-Bye Asia

By Hugh White


Hugh White

and they are much greater now. Pointers toward all three possibilities can be found in the strange farrago of ideas and attitudes which constituted his campaign for the White House and which has so far characterized his presidency. Trump’s tough-guy persona led some people to hope that he

would stand up to China and reas-sert US leadership. At the same time his “America First” isolationism and disdain for US alliances led many to fear that he would be happy to abandon US strategic commitments in Asia and leave the region to look

after itself. And yet his self-image as the ultimate dealmaker led others to wonder whether he could look for a grand bargain with Beijing, agreeing for the US to take a half-step back strategically in return for economic concessions. So which way will Trump go?

A pivotal failureLet’s start by looking back at the failed China policy Trump inherited from his predecessor. Barack Obama took it for granted that the US would sim-ply resist China’s challenge; this is what his “Pivot to Asia” was all about. His team assumed this would be easy, because it never took China’s bid for regional leadership seriously. It was convinced that China was too weak economically, militarily and diplomatically—and too fragile politically—to contemplate any real challenge to American power.

It also believed that China’s leaders could be convinced that the status quo was best for them, as only American leadership would guarantee the regional peace and stability that China needs for its domestic devel-opment. So Obama’s team assumed that restating America’s resolve to remain the primary power in Asia—supported by a few small, symbolic policy initiatives—would be enough to make Beijing back off.

That is why the Pivot lacked substance. Obama’s speech launching the initiative in November 2011 spoke boldly of using “all the elements of Amer-ican power” to uphold his vision of a US-led Asia. But it was not followed by any major redeployments of US diplomatic or strategic strength. Instead all we saw was a modest program of military deployments, a minor uptick in defense engagement activities, a meaningless commitment to deploy a larger share of a shrinking navy to the Pacific, and the rebadging of the Trans-Pa-cific Partnership (TPP) trade agreement as a major strategic initiative.

In Washington these policies were deemed sufficient to deter Beijing and secure America’s claim to the leadership of Asia for decades to come.

Under Obama, the US failed to take China’s bid for regional

leadership seriously



But on the ground this proved quite wrong: China was emboldened rath-er than deterred by the Pivot. Far from showing that America’s resolve was stronger than China’s, it provided an opportunity for China to show precisely the opposite. Beijing deliberately created situations in which Washington had to choose whether to confront China’s provocations and risk an armed clash, or hold back and see its credibility in Asia erode. Repeatedly, Washington raised expectations by talking tough, only to back off when the crunch came.

Who’s the paper tiger?This reality was starkest in the South China Sea, where the US boldly condemned China’s construction of military bases on artificial islands and demanded that it comply with the findings of the Hague Tribunal hand-ed down in 2016. But after the Obama administration promised tough action, including freedom of navigation operations to contest China’s claims and uphold the ruling, it backed down. It became plain that Obama was not willing to risk a confrontation with China that might spark an armed clash, both out of concern that it might escalate into a full-scale war and because it could disrupt cooperation with Beijing on other vital issues—such as climate change.

Although China never recklessly sought a confrontation in the South China Sea, it was more willing than the US to risk one. Beijing judged that Obama would back off first, allowing it to enhance its credentials as regional leader while undermining Washington’s. We have seen the consequences in Southeast Asia. Obama’s team had assumed that China’s neighbors would willingly flock to America’s side and seek its support as they grew more and more concerned about China’s bullying. The Pivot was supposed to encourage this. But that underestimated Asian countries’ commitment to good relations with China—which they see as essential to their economic future—and overestimated their confidence that the US could, or would, do much to shield them from China’s power.

Asian confidence in US power and resolve has been sapped both by Washington’s timidity in the South China Sea and by its failure to secure support for the TPP, which the Obama administration itself set up as a test of US resolve and commitment in Asia. Instead, most Asian coun-tries have confirmed their commitment to economic engagement with

Although China never recklessly sought a confrontation in the South China Sea, it was more willing than

the US to risk one


Hugh White

China, readily joining key Chinese initiatives like the Asian Infrastructure Investment Bank and the Belt and Road Initiative. Several Southeast Asian countries are studiously cultivating their ties with China. This includes not just Cambodia and the Philippines under the mercurial Duterte, but also Thailand, Indonesia, Malaysia and even Vietnam.

Confronting a new reality The upshot is that China’s influence in Asia today is stronger than it was in 2011 when the Pivot was launched, whereas America’s is weaker. Washington’s lack of commitment has undermined its regional leadership, shaking the confidence of its friends and allies. Its failure reflects not just maladroit diplomacy, but a fundamental misunderstanding of how wealth and power have shifted in Asia over the past decade or two.

Much of America’s foreign policy establishment remains in denial about China’s economic achievement and its implications for its place in Asia. They overestimate the scale and significance of China’s economic and political problems. Those problems are very real, but they do not credi-bly threaten China’s place as the world’s second biggest economy, nor its chances of overtaking the US to become Wthe world’s biggest economy within a few years. They do not detract from the reality that China is today already more wealthy, and therefore fundamentally more formidable, than any rival America has ever faced—including the Soviet Union in its heyday.

Moreover, while China still lags far behind the US in overall military power, its rapidly developing and tightly focused forces have already shift-ed the military balance in the Western Pacific significantly. Gone are the days when America could assume a swift and decisive victory over China at sea. Today the losses in a localized clash would be much more equal, and a costly and inconclusive stalemate the most likely result. Both sides would therefore face intense pressure to escalate, raising the prospect of a wider regional war and even a nuclear exchange.

Such scenarios may seem remote, because of course neither side wants a war. But as their contest for leadership in Asia has intensified, the pos-sibility of an escalating military conflict weighs heavily in the calculations of both Washington and Beijing. Both sides have raised the stakes with overt military posturing in the South China Sea. Each is trying to con-vince the other that it is willing to resort to force in order to assert its claim to regional leadership, and hoping that this will force the other side to back off. Under Obama, the US blinked. But this complex and dangerous game of bluff could easily lead to a conflict if one or both sides miscalcu-late. And now it is Trump’s turn to play.



There are no easy options for Trump in Asia. Whoever had won the presidency last November would have faced one of the most formidable foreign policy challenges in US history. China is now in almost every way America’s most important partner in the world, and yet it also poses the most serious long-term challenge to the US’s post-War role of global lead-er. Is there a way to preserve the relationship with China while deflecting the challenge it presents?

It is now clear that, contrary to Obama’s assumption, China won’t sim-ply back off. All the evidence so far suggests that China is indeed at least as determined to become the new regional leader as America is to stop it. That is why Trump faces such a stark choice between the three options outlined at the top of this piece.

Deal neededIt is clear that for Asia, at least, and perhaps also for the US, the best option by far would be for Washington to do a deal with China. But that would require an extraordinary feat of supple and sophisticated statecraft. Trump would need to be genuinely accommodating, conceding a large enough share of regional leadership to at least partly satisfy Beijing’s ambi-tions. He would need to extract big concessions from Beijing in return. And he would need to convince China to abide by the deal, by making it unambiguously clear that America would do whatever was necessary—including going to war—to enforce it. This would tax the intellect, energy, focus and discipline of even the most experienced and committed diplo-mat. From all we have seen of him, it seems extraordinarily unlikely that Trump can rise to this challenge, or could carry America with him if he tried. Unfortunately, then, the best outcome looks by far the least likely.

The worst outcome would be for the US-China contest to flare onto a regional war. Many people have worried that Trump’s erratic and bullying character might lead him to act aggressively in a crisis, increasing the risk that a minor confrontation might slide into conflict. It is a reasonable con-cern, amplified somewhat by his seemingly impulsive decision to launch a missile strike on Syria, and by his recent threats towards North Korea. Still, the chances of him deliberately launching a conflict with China are slim. The more serious risk is that in a tense moment he might tweet himself into a corner. If he makes loose and ill-considered threats which China bla-

The evidence suggests that China is at least as determined to become the new regional leader

as America is to stop it


Hugh White

tantly ignores, he may feel that the only way to avoid humiliation is to carry out his threats. That is how wars have often started in the past, after all.

The most likely outcome, however, is that America’s strategic role in Asia will steadily dwindle. That has less to do with Trump himself than with the underlying geopolitical dynamics of Asia. Trump will find, as Obama did before him, that the costs and risks of confronting China in Asia are just too high. Indeed he has already found this. Having cam-

paigned on tough talk against China, and rattling the relationship during the transition with threats to review the “One China” policy, the new president has gone out of his way to reach out to Beijing on a wide range of issues. Hard-line China hawks like

Peter Navarro and Steve Bannon have been sidelined, while those favoring a more cooperative line like Jared Kushner seem to have prevailed.

This became clear when Trump hosted President Xi at Mar-a-Lago in April, where he blithely swept problems in the relationship aside while Xi apparently conceded nothing. Likewise, recent developments suggest that Trump is as reluctant to confront China in the South China Sea as his pre-decessor was. According to the New York Times, repeated requests from US Pacific Command to conduct freedom of navigation operations there were turned down, until a warship was finally permitted to sail within 12 nautical miles of a Chinese-claimed island near the Philippines in late May. This initial reticence did not go unnoticed elsewhere in Asia. And Washington’s recent barrage of threats against North Korea is also likely to undermine its credibility if, as is most likely, Pyongyang ignores them with impunity.

Asia for the AsiansAll this is good news for Beijing, which must see Trump’s behavior as offering important opportunities to erode US credibility in Asia and enhance its own claim to regional leadership. And that in turn will fur-ther unsettle US allies, especially South Korea and Japan. They have long been the key to America’s power in Asia, but their support rests on their confidence that ultimately America will be willing and able to stand up to China on their behalf.

That confidence had already been seriously eroded under Obama. Trump’s campaign lines criticizing US alliances and suggesting that Japan and South Korea should get their own nuclear weapons only added to the

The most likely outcome is that America’s strategic role in Asia will

steadily dwindle



anxiety. Despite efforts by some in the new administration to reassure them, it will become increasingly clear that President Trump is not the man to offer the kind of steady, consistent and credible reassurances they need about the strength of America’s commitment to their security. As their confidence ebbs, so too will Washington’s leadership in Asia.

To many people, including most within the US foreign policy establish-ment, relinquishing this long-held leadership is almost unthinkable. But times have changed: the costs and risks of preserving regional primacy, or even maintaining a lesser but still important role in Asia’s strategic affairs, are much higher now as China’s power and ambitions have grown. And, crucially, American voters’ willingness to shoulder those costs and risks have diminished. That is the real lesson of last year’s election: on both sides of US politics, insurgent candidates—Donald Trump and Bernie Sanders—showed that the American electorate sees higher priorities at home than abroad. If America no longer believes it must lead the world, Asia must prepare to go it alone.


While China’s trade with Southeast Asia flourishes, a lack of experience has left its investment in the region lagging far behind. For now, Southeast Asian countries will continue to work with Japanese, EU and US institutions—regardless of

how attractive China’s initial bids are.

If one were to believe Chinese trade statistics, China is now the top trad-ing partner for more than 100 countries. While our research shows that the real figure is closer to 40, China’s trade dominance is un-debatable in one region: Southeast Asia. Within 10 years, China has emerged as the undisputed trading power there, becoming the top trade partner of every Southeast Asian country bar Laos, where China still represents a substan-tial quarter of the country’s imports and exports, and tiny Brunei.

China is much less dominant, however, when it comes to investment. Despite its trade clout, China accounted for a mere 7% of all foreign direct investment (FDI) flows to the region in 2015—compared with 17% for the EU, 15% for Japan and 11% for the US. Indeed, Beijing is the top investor only in Laos, Cambodia and Myanmar, and comes way behind other his-torical partners such as Japan, the EU, the US or even South Korea in most of Southeast Asia’s larger economies.

China is catching up quickly, of course, displaying a firm intention to boost its investment position in the region. The Belt and Road Initiative and the Asian Infrastructure Investment Bank (AIIB) are part of the effort, as are repeated bilateral state visits featuring mouth-watering investment promises. But Beijing’s grand plans to shower the continent with “win-

Agatha Kratz is assistant editor of the China Economic Quarterly and a PhD candidate at King’s College London.


High-Speed Rail Blues

By Agatha Kratz



win” investments are clashing with a tough reality: despite billions offi-cially committed to the region, investment follow-up and execution are proving troublesome, stymying China’s goal to become the region’s top investor. In Indonesia, for example, China had hoped that winning the Jakarta-Bandung high-speed rail line would boost its status as an investor, but did not expect so many obstacles to come its way.

Competing with “Little Tokyo”Indonesia has everything to attract Chinese investors’ interest: a fast-grow-ing economy, 250mn potential consumers getting richer by the day, abundant natural resources, and a pressing need for infrastructure devel-opment epitomized by Jakarta’s nightmarish traffic. Politically, Indonesia ticks a few more boxes: it is technically part of the sea-based leg of the Belt and Road Initiative, yet has very little direct contention with Beijing over the South China Sea. Overall, Indonesia is the perfect destination for Chinese companies to export all kinds of manufactured goods and excess infrastructure capacity, but also to “go out” and grow as long-term economic players through investment.

Yet, until recently, Chinese forays into the country had been timid, with Indonesia remaining a clear Japanese stronghold. Many in Jakarta will tell you that the best Japanese food outside Japan is to be found in Indonesia. And for sure the culinary sector had to develop and meet demand as thousands of Japanese firms and many more citizens settled in the country. Both cultural and economic links between the two countries run deep. Japan International Cooperation Agency (JICA), Tokyo’s aid arm, has long been very active in the country, with Indonesia the main recipient of Japanese aid in Southeast Asia, and Japan the country’s top donor. People-to-people exchanges have also flourished: Indonesia has more high-school pupils studying Japanese than any other country, and Jakarta has its own, KTV-packed “Little Tokyo.”

So while China overtook Japan to become Indonesia’s top trading part-ner in 2015, the bilateral relation pales in comparison with the durable, friendly and comprehensive links that Jakarta and Tokyo have built over decades. In particular, despite high-paced growth over the past few years, Chinese investment in the country was for a long time underwhelming at best, and suffered from a very strong, historically rooted anti-Chinese sentiment, not to mention the dismal reputation of Chinese products and companies. Japan’s head-start in sectors of particular interest to China, such as energy and infrastructure, also meant that room for Chinese expansion was constrained.


Agatha Kratz

Where China did manage occasional headway, its track record has been mixed to say the least. For example, 10 years on, China’s disastrous partici-pation in Indonesia’s 10,000-MW power program is still on everyone’s mind. The project suffered severe delays and cost overruns, and faced intense crit-icism due to poor plant quality and performance, and nonexistent after-sale service. Similarly, China’s short-lived procurement of buses for the Indo-nesian capital harmed its reputation. Most of the Chinese buses fell apart within a couple of years, and when several of them burst into flames while in operation, they were once and for all taken off the road, and replaced by a much more expensive but stronger European and Japanese fleet.

Part of the blame for both projects falls on the Indonesian government for accepting two extremely low-priced bids, while hoping to get top-qual-ity products and services. But Chinese companies failed to deliver decent standards, and some were even accused of corrupt practices. By focusing on winning the contracts instead of their execution, these projects dam-aged Chinese firms’ reputation and image in Indonesia. Chinese success stories are also to be found in the country, but market penetration is often linked to a similar, price-based advantage. Huawei, for example, success-fully built on a partnership with the country’s main operator Telkomsel to sell its products cheaply. And Chinese contractors largely underbid competitors to build bridges and dams throughout the country, often renegotiating contracts afterwards owing to a shortage of funds.

Despite these difficulties, China has shown a strong interest in expanding its investment presence in Indonesia. Characteristically, the

China’s investment reach remains limited

China’s position as an investment partner for ASEAN countries (2014)

China’s share of China’s rank Top inward FDI as investor* investor*Brunei Darussalam 0% n/a EU-28Cambodia 32% 1st ChinaIndonesia 5% 2nd Japan Laos 67% 1st ChinaMalaysia 2% 3rd EU-28Myanmar 8% 1st ChinaPhilippines 1% 4th EU-28Singapore 7% 4th EU-28Thailand 9% 4th JapanVietnam 2% 4th S Korea

*Excluding ASEAN ASEAN Statistical Yearbook 2015



move has been largely state-led. In October 2013, Chinese companies followed Xi Jinping to Jakarta for his first official visit to the country, and signed agreements worth US$30bn. The return visit to Beijing in March 2015 saw the state-owned lenders China Development Bank (CDB) and Industrial and Commercial Bank of China (ICBC) commit to a five-year, US$50bn joint loan facility in support of Indonesia’s infrastructure.

Timing played in China’s favor, thanks to the 2014 election of Joko “Jokowi” Widodo, an “economy first” president boasting fresh priorities compatible with China’s own ambi-tions. Jokowi’s plan for Indonesia is simple: boost growth, competitive-ness and employment by tackling the country’s dire need for infrastructure investment—about US$600bn over the next five years according to the World Bank. But such ambitions are expensive, and the country has neither high commodity prices nor a stur-dy taxpayer base to help it bridge the financing gap. So Jokowi has been looking outward for investment, and quickly jump-started fundraising efforts after his election, with back-to-back visits to Japan and China in March 2015.

While Jokowi’s visit to Japan was a continuation of established practic-es, his willingness to court its Chinese partner, including by volunteering to become an AIIB founding member, was a noteworthy evolution. Jokowi has indeed appeared much more open to Beijing than his predecessors, with a pragmatic approach to economics and a tendency to favor China’s infrastructure-led model of development. Jokowi’s turn to China also marks a desire for diversification from an omnipresent Japan, and an intention to play Sino-Japanese rivalry to Jakarta’s advantage. All in all, China has benefited from a new Indonesian willingness to look beyond Japan, and promote a warming up of bilateral ties.

Winning the infrastructure arms raceIn this context, the idea to promote a flagship bilateral project was attrac-tive to both countries. During Jokowi’s visit to Beijing in March 2015, both sides discussed the possibility of a Chinese consortium participating in the construction of Indonesia’s first high-speed rail line from Jakarta to Bandung. An MOU was soon signed, and China’s National Development and Reform Commission committed US$5mn to start feasibility studies on the line.

China has benefited from a new Indonesian willingness to look beyond Japan, and promote a

warming of bilateral ties


Agatha Kratz

Yet this was not the first time high-speed rail was contemplated in Indonesia: Japan had been eyeing the project since 2011. By the time of Jokowi’s Beijing visit, Japan had already financed US$4mn worth of studies for the project through JICA, hoping that such investment would secure a key role for its companies in its delivery. China’s invitation to bid upset Tokyo’s plans and forced it out of its Indonesian comfort zone. Tokyo woke up one grim March 2015 morning facing a fierce competi-tor: a country with 20,000 km of high-speed rail, just as much financing capacity as its own, and a genuine desire to win this contract for political and economic reasons. Indeed, not only did Beijing see the project as a token of “win-win” cooperation with its long-forgotten Southeast Asian partner, but it would mark China’s first actual high-speed rail project abroad after years of effort.

For these reasons, the Chinese side did all it could possibly do to win the project. For one, it met all of Indonesia’s conditions, needing neither a state guarantee on the project loan nor a budgetary contribution from the Indonesian state, and promising delivery by May 2019—right in time for Indonesia’s next presidential election. But the Chinese offer went a few steps further. It included a joint venture with Indonesian partners under Indonesian majority control, the promise to build a rolling-stock manu-facturing plant in Indonesia, significant skills and tech transfers, and the pledge to create no fewer than 40,000 jobs per year.

With such conditions, China held a very strong offer compared to that of Japan, which boasted a much lower interest rate than China’s (0.1% com-pared with 2%), but demanded that at least 10% of the project be financed through Indonesia’s state budget, and 50% of it be backed by a government guarantee. As a result, Indonesia decided to hand the project to the Chi-nese-led consortium KCIC in late September 2015, to the ire of Tokyo.

High-speed, high-risk diplomacyA sign of its dedication to win, China’s proposed project structure marks a clear deviation from its usual model of infrastructure development. A business-to-business rather than government-to-government venture, it has no guarantee from the Indonesian state—be it financial, or in the form of land or natural resources—yet comes with concessional financing from CDB for 75% of the project. Beijing also accepted that Chinese contractors would not be in charge of all aspects of the project. Instead, four Indo-nesian companies are involved, as partners rather than sub-contractors, which will take on 30% of the construction. Even more interesting, China deviated from its preferred finance-build-and-transfer approach to a con-



cession model, thereby tying Chinese companies and capital to the project for a much longer period of 50 years. In short, to secure this large, visible and symbolic project, China accepted much more financial, operational and political risk than it usually feels comfortable doing.

Since the contract was triumphantly won in late 2015, however, the Chi-nese railway engine has hit a wall: 18 months after a groundbreaking cere-mony, the project has yet to start construction. Responsibility for the delays is shared between China and Indonesia, and linked to Jakarta’s inability to secure land for the line, which in turn feeds CDB’s reluctance to start dis-bursing funds. Tough negotiations are underway, with CDB requiring that 100% of the land be secured before construction starts, while KCIC hopes 80% will be enough. Even if an agree-ment is reached, further delays are to be expected, as land acquisitions and administrative procedures are infamously painful in Indonesia.

China’s struggle to deliver on the Jakarta-Bandung line, even with sub-stantial political and financial backing, is not an isolated case. Rather, it is one more illustration of its difficulties to turn its current Asian ambitions into practice. Taking the rail sector alone, China has promoted bilateral projects in Thailand, Laos, Vietnam and Myanmar. The first two have been lagging since 2010, while the last two were eventually dropped. Fur-ther afield, China’s ambition to build Russia’s Moscow-Kazan high-speed railway in time for the 2018 Football World Cup is now a distant memory.

Winging it won’t workIt is worth repeating that the blame for such difficulties is shared between Beijing and host countries. Yet China’s faux pas are undeniable. It often overpromises and under-delivers because of a lack of conscientious preparation and planning. In the Jakarta-Bandung case, China’s feasibility studies were delivered within a couple of months, compared with four years on Japan’s part; and those who got to see them thought they were extremely “thin.” Such unpreparedness is compounded in some countries by insufficient understanding of the local legal, political or social context. In Thailand, NGOs act as a strong counter power, even under military rule. And in Russia, China’s opportunities and negotiating power are a function of EU sanctions against Moscow.

This lack of experience can sometimes be mitigated. In the case of the Jakarta-Bandung line, China insisted that a non-rail player, Sinohydro, be

Too often, China overpromises and under-delivers because of a lack of

conscientious preparation


Agatha Kratz

included in the project company. Sinohydro has extensive experience both in the infrastructure sector in Indonesia, and working with China’s main Indonesian partner and contractor in the joint venture, Wika. Without Sinohydro, none of the Chinese companies involved would have had any experience working in Indonesia; and actually, most Chinese rail compa-nies have never delivered a full high-speed rail line outside of China.

But China’s investment ambitions in Southeast Asia will continue to face a tough reality: while trade flourishes, the implementation and exe-cution of investments remain weak points. Changing this will likely take a very long time. As China racks up high-profile failures of execution, Southeast Asian countries will retain a preference for working with other, more experienced players such as Japan, the EU or the US—and this no matter how attractive China’s initial bids may be.


The past few months saw a flurry of regulatory measures to tackle risks in the financial system. Beijing is trying to avoid a credit crunch, but the effect on the economy will depend

on how far these measures are implemented.

Chinese financial officials have stirred up a regulatory storm over the past few months, ordering a crackdown on various forms of speculation, arbitrage and risky behavior. These regulatory changes could lead to further tightening of domestic liquidity in the next six months, although much depends on how the new priorities are implemented. But regulators will have to tread very carefully to avoid creating too much of a shock to liquidity and credit creation. While maintaining financial stability and current economic growth rates are still the political bottom lines, regu-latory action has put pressure on the domestic equity and bond markets.

A flurry of new regulationsThe on-going, coordinated push for tougher financial regulation is quite unusual. All the regulators seem to be competing to demonstrate that they are working hard to follow the top-level call for curbing financial risk made at the Central Economic Work Conference in December 2016—and reiterated by the Politburo meeting chaired by President Xi Jinping in late April. The continued strength of the economy seems to have given policy-makers confidence that now is the right time to squeeze out some of the excesses in the financial system.

The People’s Bank of China already raised short-term policy rates twice this year, and at the end of March it implemented a tougher version of its

Chen Long is the China economist at Gavekal Dragonomics.

Economy

The Regulatory Storm

By Chen Long


Chen Long

macro-prudential assessment system for financial institutions. Liu Shiyu, the outspoken chairman of the China Securities Regulatory Commis-sion (CSRC), has been publicly criticizing the “financial crocodiles” who manipulate the equity market, and the Commission has ordered broker-age firms to review their asset management businesses.

The most drastic changes come from two commissions with new top regulators. After an anti-corruption investigation snared its then chairman Xiang Junbo and discredited his hands-off approach, the China Insurance Regulatory Commission (CIRC) is stepping up oversight of insurers with a number of new documents. Private insurers who experienced rapid growth by selling short-term investment products such as Anbang Insurance and Foresea Life are now facing tremendous pressure to reduce their expansion.

Another aggressive regulator is the China Banking Regulatory Com-mission (CBRC), under its new chairman Guo Shuqing, a well-regarded former central banker. In the two months since Guo replaced the retired Shang Fulin, the CBRC has issued no fewer than eight documents ordering commercial banks to improve risk management and rectify their behavior:

• No.4:On improving banks’ support to the real economy• No.5:On rectifying the disorder in the banking sector• No.6:On preventing and controlling risks in the banking sector• No.7:On improving the effectiveness of regulation• No.45:Launch of a special enforcement action for three types of viola-

tions (“violating laws,” “violating regulations,” and “violating rules”)• No.46:Launch of a special enforcement action for three types of arbi-

trage (“regulatory arbitrage,” “interbank arbitrage,” and “related-par-ty arbitrage”)

• No. 52:On further investigating the hidden risks in firms’ mutual guarantees

• No. 53: Launch of a special enforcement action for four types of inappropriate activities (“inappropriate innovation,” “inappropriate transactions,” “inappropriate incentives,” and “inappropriate fees”)

MostinterestinginthislistareDocuments46and53,whichrequirebankstoconductadetailedself-inspectionoftheiractivities.Document46ordersbanks to assess three major categories of arbitrage: “regulatory arbitrage” (changing the regulatory form but not the substance of a transaction); “interbank arbitrage” (transactions that “lengthen the chain” of financing by moving funds through different institutions); and “related-party arbitrage” (the use of transactions with associated firms to dodge regulations). An


Economy

attachmenttoDocument46listsmorethan90differentformsoffinancialarbitrage, in a kind of encyclopedia of regulatory shenanigans. Similarly, Document53 requiresbanks toassess their involvement ina long listofunsafe practices.

Specifically, both documents ask banks to report to the CBRC if they have made investments or loans via a complex structure that involves multiplestepsoftransactions.Document46alsoasksifabankhasusedinterbank borrowing to increase the size of its balance sheet and make investments in the capital market. For many if not most banks, the answer tobothofthesequestionswillbeyes.Document53asksbankstoreportifthey get more than one-third of their funding from other banks, a thresh-old that at least a few mid-sized banks have already crossed.

Both documents are fundamentally about assessing the risk of increas-ing interconnectedness among financial institutions, as well as banks’ rising reliance on interbank funding—what I have previously called the two main “weak links” of the financial system. Banks have to submit their responsestoDocuments46and53byJune15andJuly15respectively.

Cleaning up the mess will be dangerousWhat happens after that is far from clear. All we know for now is that it will take a few more months after the summer for the CBRC to come up with new regulations, and implement them. There is no question that

What non-bank financials do with their money

Data as of December 2016

Stock andbond markets

RMB8.6trn

Credit to realeconomy

RMB17.2trn

Unallocated(cash)

RMB0.7trn

Fund specialaccounts

RMB2.9trn

Fund managersubsidiariesRMB5.8trn

Brokerage assetmanagement

RMB11trn

TrustcompaniesRMB3.8trn

Bank lending tonon-bank �nancial

institutionsRMB26.5trn

AMAC, Gavekal Dragonomics


Chen Long

regulators have correctly identified the major issues plaguing the finan-cial system, but the problem is how to implement change after all of this information is gathered. While regulators have given banks very detailed checklists for the self-assessments, the documents are not at all clear about how banks should change if they are violating the guidelines, and what sanctions they might face if they fail to do so. What is clear, however, is that “inappropriate” transactions and financial arbitrage are system-wide phenomena in China, rather than the actions of a few isolated entities. Basically every commercial bank in China is involved in at least some of the long list of activities now targeted by regulators.

Therefore, this regulatory campaign cannot eliminate all of these misbehaviors without causing a severe reduction in liquidity and credit, which would very likely put financial institutions at risk and cause a sharp deceleration of economic growth. On the one hand, regulators are clearly feeling political pressure to show that they are acting on Xi Jinping’s direc-tive to contain financial risk. On the other hand, they know they cannot gotoofarandtriggeranear-crisissuchastheinterbankcrunchof2013,or the more recent bond-market problems in late 2016. Regulators would inevitably take the blame for such a failure, and would be forced into an embarrassing reversal of policy to contain the damage.

Although there is no real clarity yet about enforcement, the coordinat-ed regulatory campaign is already having an effect. One of the simplest


Economy

indicators to track its impact is the growth of bank lending to non-bank financial institutions (NBFIs)—one of the main arbitrage channels forbanks, who use it to move funds from one regulatory regime to another. BanklendingtoNBFIsusedtobeatinyportionofbanks’balancesheets,but it started to grow rapidly in late 2010, and maintained an annual growthrateofover50%from2012to2016.SuchlendinghasnowreachedatotalofRMB26.5trn,equivalentto23%ofallbanklendingtothecor-porate and household sectors. So it is no longer a marginal part of the financial system. But its growth has decelerated sharply in recent months, to22%inAprilfrom50%inDecember,asbanksrespondedtothePBOC’slatest macro-prudential assessment.

Markets are feeling the pain Another immediate impact of the regulatory tightening is a series of adjustments in the domestic financial market. One-third of bank lending toNBFIs,oraboutRMB9trnaccordingtomyestimates,flowsintodomes-tic bonds and equities. This is exactly the type of transactions now being scrutinized by regulators. It is reported that some NFBIs have startedreducing their positions, which led to sharp rises in bond yields as bonds accountforthemajorityofNBFIexposuretothecapitalmarket.Bench-mark 10-year Chinese government bond yields have increased by about 100bps from last year’s low, and corporate bond yields on average have


Chen Long

risenby200bps.Bothhavehittheirhighestlevelsincelate2014.Equitymarkets are also increasingly nervous about the escalating pressure: the Shanghai Composite had a good rally earlier this year thanks to better corporateearningsuntilearlyApril.Butithassincedeclinedby7%amidreports that banks are starting to withdraw funds from asset managers, and underperformed the H-share market.

One of the main consequences on the real economy is that credit growth has slowed due to the decline in bond financing. Net govern-mentbond issuancehasdroppedby55%fromayearago,and thecor-porate bond market suffered even more as net issuance was negative

RMB100bn in the first four months, against RMB1.6trn during the same period in 2016. Still, although the decline in corporate bond financ-ing has dragged down overall credit growth, the deceleration has been

quite slight so far; credit creation via bank loans and trust loans is still strong. This slowing trend of credit growth will be reinforced by the new CBRCregulations,astwo-thirdsoflendingtoNBFIsisdefacto“hidden”credittotherealeconomy,amountingtoabout10%oftotalcredit.Buttheexact impact of these moves will eventually depend on how, and how far, the new regulations get implemented after the summer.

Growth of credit to the real economy is slowing due to the drop

in bond sales


Shifting China’s industrial production from low-margin assembly to high-value, technology-intensive goods has long

been the Holy Grail for planners. Export data show a lot of progress, but also an enduringly high reliance on foreign

components, technology and management.

China has long had the ambition to emulate the success of Japan and South Korea in climbing up the value chain to produce more technology-inten-sive products. Policymakers are frustrated that, in many product categories, China has been restricted to the low-value role of final assembler in Asian production chains. The epitome of that problem is the iPhone. A 2010 study by the Asian Development Bank found that only 4% of the value embedded in China’s most visible consumer export was added in China.

China’s techno-anxiety is not limited to the desire to increase its share of profits in global consumer markets. Technological self-sufficiency at home, and making the country a key source of capital goods (such as con-ventional and nuclear power plants, mining and construction equipment, and high-speed trains), are also key goals. A series of initiatives, most recently the comprehensive industrial policy “Made in China 2025,” aim to increase the technological capacity of China’s manufacturers, enabling them to capture greater market share both at home and abroad. They also aim to lengthen supply chains within China, reducing the country’s reli-ance on imported high-value components.

How successful are these efforts? A look at the export data shows a decidedly mixed picture. On the positive side, China’s share of global

Arthur Kroeber is editor of the China Economic Quarterly. Dan Wang is an analyst at Gavekal Research.

Trade

The Export Upgrade Challenge

By Arthur Kroeber and Dan Wang


Arthur Kroeber and Dan Wang

manufactured exports continues to rise at a steady rate, indicating that higher wage costs and exchange-rate appreciation are not eroding overall competitiveness. In absolute terms, exports of industrial machinery dou-bled between 2008 and 2016. And “processing”—the final-stage assembly of imported components and materials—has shrunk to about a third of the country’s export basket, down from nearly 60% a decade ago.

Various measures of the technological sophistication of exports are less encouraging. High-tech goods’ share of total exports has remained essentially static for the past 10 years, and over 80% of high-tech exports are still produced by foreign companies. Many of China’s capital-goods exports remain heavily dependent on key imported components. And the story that China could accelerate the progress of its heavy industry by becoming the capital-goods purveyor of choice for developing coun-tries—for instance through the Belt and Road Initiative—seems question-able. The lion’s share of China’s exports still go to rich-country markets, where the last couple of years have seen a leveling-off of demand.

A long march upwardWhen we examine China’s place in global trade, the single most striking fact is the consistency with which its share of the world’s export pie has risen since it joined the World Trade Organization in December 2001. On average, China’s share of world manufactured export value has grown by


Trade

one percentage point a year, rising from 5% on the eve of WTO entry to nearly 19% in 2015. In the decade before WTO entry, China’s market share gains were more stately—about a third of a percentage point per year.

Its share of total export value is a bit lower (14%) and has risen at a slower pace of around two-thirds of a percentage point a year. The dis-crepancy largely reflects the long boom in the commodities trade, where China is mainly an importer rather than an exporter. In any case, the man-ufactures numbers are what matter for an analysis of technological trends.

There is little evidence that these gains are slowing down: the average annual market share gain in manufactured exports was greater in 2011-15 than in the prior four years. By the end of this decade China could well account for 22-23% of global manufactured exports, well above its present share of world population (19%) or GDP (15%).

Diversifying nicelyThis top-line figure matters for a couple of reasons. First, it constitutes prima-facie evidence of China’s success in diversifying to higher-value exports. Such steady market share gains could not be achieved simply by bulking up on shipments of low-end products. Second, it mandates caution when interpreting the composition of China’s export basket. As we will see below, several indicators suggest that higher-value industrial goods are relatively stagnant as a share of China’s total exports. But if China’s

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exports are rising as a share of the world total, then such “stagnation” could easily coexist with a rise in China’s market share in these categories.

That said, the sectoral data do suggest that Chinese firms face a strug-gle as they try to capture a bigger share of the market for technology inten-sive goods. Using standard definitions of technology intensity, high-tech goods have remained stuck at about a third of China’s export basket since 2005. Expanding the definition to include “medium-tech” goods pushes up the share to around 55%; but the general picture of stasis remains.

Perhaps more tellingly, China has in recent years failed to match the success of its neighbor South Korea in shifting to an export basket dom-inated by machinery. This is interesting because China’s overall develop-ment strategy has closely emulated South Korea’s, and in general their industrial trajectories have tallied quite closely. But as the chart above shows, when South Korea hit China’s present level of per-capita GDP, fully 40% of its exports were in non-electronic machinery, compared with 25% in China today.

Here we need to be careful. Comparisons between a huge China—with its abundant labor and resource endowments—and a smaller and much more resource-constrained South Korea can only go so far. The relatively slow-growing share of high-end exports may simply be a function of China’s unusually durable strengths at the low end. A small, resource-constrained country like South Korea or Taiwan must swiftly exit low-value export cat-


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egories once costs rise too high. China may be able to retain more of this business for longer because of its larger labor pool, greater economies of scale and stickier supply-chain clusters, and its big internal market.

Sectoral export data provides some support for this hypothesis. Viewed as a share of China’s export basket, most high-end categories are stagnant or growing relatively slowly. But in absolute value terms most of these same categories grew smartly until quite recently. As the chart on the next page shows, from 2008 to 2014 exports of telecoms equipment, various categories of machinery and power-generation equipment all roughly doubled. (A slowing and then absolute decline in the value of computer exports probably has less to do with a loss of competitiveness than with the commoditization of personal computers and the rapid shift from desktop to mobile devices.)

So we should probably not make too much of the failure of high-end categories to increase their share of China’s unusually broad and diverse export basket. Yet the most recent data does suggest that high-end Chi-nese exporters have hit some challenges. The combined value of the main categories of ICT and industrial goods exports both peaked in 2014 (at US$489bn for ICT and US$468bn for industrial goods), and in the two years since have declined by 4% and 1% respectively.

Some of this can be laid at the door of the relatively weak global demand environment of that era. And industrial goods exports almost



certainly suffered from the 2014-15 collapse in commodity prices, which demolished capex in most extractive industries. There are also some ques-tions about the quality of Chinese export value data in 2015-16, which showed significantly lower growth than partner-country data on imports from China, probably because of Chinese exporters disguising capital flight by under-invoicing their shipments. But it will be worth watching this space carefully to see if high-end Chinese exports pick up along with global demand, or stay stuck in a low-growth rut.

The very visible foreign handThe next set of questions relates to how much China’s high-value exports are dependent either on imports or on foreign management. The key indicators here are a) the share of low-margin processing trade in total exports, b) the import intensity of capital goods, and c) the share of high-value exports that are produced by foreign-invested enterprises (FIEs; a category that also includes Taiwan- and Hong Kong-owned firms). The picture that emerges is of an export sector that still relies heav-ily on foreign inputs—far more so than the export sectors of Japan, South Korea or Taiwan at comparable stages of development.

The heyday of the processing trade—in which imported components are snapped together in China and then re-exported—was 1996-2006, when processed exports consistently accounted for 55-60% of China’s


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total. They then steadily declined to about a third of total exports by 2015. The decline is steep, but processing’s proportion of China’s trade is still very high. Moreover, an uptick in processing activity in 2016 suggests that the fall in reliance on processing may be at an end, and that low value, final-stage assembly will continue to be a big part of China’s export picture for some years to come. (This is consistent with the story that China has a unique ability to hang on to low-value production sectors for longer than most other countries.)

Turning to the import intensity of capital goods—that is, the ratio of imports of capital goods components to capital goods exports—we can see that after a sharp decline in the early 2000s, since 2008 this has held fairly steady at 55-60%. Without detailed sectoral work it is hard to know for sure what this means: domestic content is probably quite high in some traditional products (such as construction and power-generation equipment) and almost certainly quite a bit lower in new sectors (such as industrial robots, where studies have found that about 75% of the value of Chinese-produced robots comes from components imported from Japan and South Korea).

If China is adding new, import-intensive sectors at a rapid rate, this could keep the import ratio high for a number of years; but it could then fall quickly once Chinese firms master the component techniques and the number of mature sectors exceeds the number of sunrise sectors. None-



theless, the stabilization of the import-intensity ratio since 2008 suggests that as China moves higher up the industrial value ladder, it becomes ever harder to fully domesticate the supply chain.

Less ambiguous is the role of foreign companies. FIEs’ share of total exports has steadily declined from its peak of almost 60% in 2006, but still stands at over 40%. In sectors defined as “high-tech” by Chinese statisti-cians, the FIE share of exports is still close to 80%, down only marginally over the past decade. Of this figure, three-quarters is accounted for by wholly owned subsidiaries of foreign firms and only one-quarter comes from joint ventures where there is at least a theoretical chance of technol-ogy transfer to the Chinese partner.

This enduring reliance on foreign management remains an extraordi-nary feature of China’s industrial structure, and distinguishes it sharply from Japan and South Korea, whose export behemoths were composed almost exclusively of domestic firms. Another striking example of China’s dependence on foreign inputs is its international intellectual property licensing ratio—that is, the ratio between the revenues Chinese compa-nies earn by licensing their IP to foreign firms, and the fees they pay to license foreign IP. For the United States, unsurprisingly, this ratio is quite high: its firms generate three dollars of international licensing revenue for every dollar they pay out. Japan, Germany and the UK also enjoy ratios well above one. For China, according to a forthcoming study by the Cen-


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ter for Strategic and International Studies, the figure is just 0.05: in other words, China generates just five cents of international licensing revenue for every dollar it pays out—one-sixtieth of the US ratio.

Belt and Road to the rescue? Maybe notA final issue is whether China can derive some special benefit from being the capital-goods supplier of choice to developing countries that want to install a lot of infrastructure in a hurry at low cost. This goal is clearly embedded in the national industrial strategy, and makes up part of the motivation for the Belt and Road Initiative. The reality is that while devel-oping countries have indeed become more important markets, Chinese exporters remain overwhelmingly leveraged to rich-country demand.

Between 2006 and 2014, capital goods exports to developing countries rose from US$50bn to US$250bn. But capital goods exports to devel-oped countries rose much more in absolute terms, from US$300bn to US$660bn. In 2015 both figures declined a bit, presumably because of the reduction in capex triggered by the commodity-price collapse. In 2015 the value of China’s consumer-goods exports to rich countries was still more than twice the value of its capital-goods exports to developing nations.

In share terms, combined exports of capital and consumer goods to rich countries have fallen a bit from 60% in 2006 to 53% in 2015; con-versely the developed country share has risen from 13% to 19%. (The



remaining 20-25% of China’s exports are of primary products and materi-als such as steel, which we have excluded from these calculations because our main concern is to figure out China’s trajectory in producing complex, technology-intensive manufactured goods.) There is clearly a gradual shift in favor of emerging markets, but it is scarcely game-changing. And the inauguration of the Belt and Road Initiative in 2013 has so far had little discernible impact.

This finding is problematic for those who want to make extravagant claims for the material effect of China’s infrastructure diplomacy, or for the decoupling of the fortunes of emerging markets (including China) from the cycles of rich-country demand. But it is actually a positive signal for China’s technological capacities. If Chinese producers were able to export capital goods only to the likes of Indonesia and Nigeria, one might justifiably suspect that they could only compete on price. Their ability to broaden their sales of higher-value goods in more demanding developed markets suggests that technological improvement is also part of the story.

Progress, at a high costThe overall conclusion is that China is making significant inroads into higher-value sectors, and steadily increasing the technology intensity and domestic content of its exports. It will almost certainly continue to increase its share of the gross value of global manufactured goods exports.


Trade

But progress is gradual, and higher-value Chinese production remains dependent to an extraordinary degree on imported components, foreign intellectual property and foreign management.

The main implication is that we should, as always, be skeptical of breathless claims that well-financed Chinese companies are on the brink of overrunning and dominating various high-end technology or indus-trial goods markets. Despite billions of dollars of subsidies and market protections doled out by Beijing under successive waves of industrial policy over the past 20 years, China’s record of success in technological upgrading, while impressive, has been very patchy. The current wave of industrial policy, under the banner of “Made in China 2025,” is likely to follow the traditional pattern of massive government inputs, substantial waste and mixed achievements.


Within China’s increasingly restrictive political landscape, neo-Maoists continue to thrive. Tolerated for now as Xi’s

ideological allies, they could turn into his fiercest opposition should he surprisingly uphold his Third Plenum pledge to

give a “decisive role” to the market.

Since his rise to power in 2012, Xi Jinping has overseen one of the most far-reaching and concerted ideological crackdowns in the post-Mao era. Journalists and lawyers have been jailed; NGOs and independent think tanks shuttered. Most recently, the pro-market reform think tank Unirule Institute of Economics had its doors padlocked for “security reasons” during the Belt and Road Forum, while the gadfly magazine Yanhuang Chunqiu suffered a dramatic purge of its liberal editorial board. Yet one group has remained conspicuously unscathed: China’s so-called “neo-Maoists.” With their long-standing advocacy of a muscular Com-munist Party (CCP), increased control of state-owned enterprises (SOEs) and the rehabilitation of Mao Zedong, they have found an ally in General Secretary Xi Jinping.

As the 19th Party Congress approaches this autumn, foreign compa-nies, investors and governments are trying to predict the future of Chinese economic policy. Has President Xi been consolidating power in order to drive through a painful program of economic reform and liberalization? Or will his “turn to the left” endure, and politics continue to top his agenda?

Jude Blanchette is the Engagement Director at The Conference Board’s China Center for Business and Economics. He is completing a book on the legacy of Mao Zedong in contemporary China, to be published by Oxford University Press in 2018. The views expressed here are his own.

Politics

Still Holding High Mao’s Banner

By Jude Blanchette


Politics

The neo-Maoists believe Xi’s actions since assuming power are proof that he will enforce his pledge from 2013 that “our red nation will never change color.” Should Xi instead make good on a more famous pledge made that year—to give the market a “decisive role” in allocating resources—they could prove an irritating thorn in his side.

Beyond UtopiaExisting within a system that shows no tolerance for party politics, the neo-Maoists have over the past decade grown to become the only signif-icant political movement in China tolerated outside the CCP. The group exists as a network of websites, student associations, discussion groups, tourism companies and intellectuals, both within think tanks and uni-versities and within the military and CCP itself. The neo-Maoists, much like the Tea Party in the US, have re-shaped the parameters of political debate by demanding that the CCP’s founding ideals (re)occupy the cen-ter of popular discourse. They utilize the latest in digital tools to promote a vision of a strong, socialist and revolutionary China. Theirs is a world where the vocabulary of Marxism—class struggle, alienation, dialectical materialism—seamlessly commingles with the language of computer cod-ing and HTML.

At the heart of the movement is the Utopia group, founded as a pan-leftist website and bookstore in 2003 by intellectuals who felt social-ism and nationalism had been marginalized by China’s post-Mao leader-ship. In the shattering of the “iron rice bowl” under Premier Zhu Rongji, Jiang Zemin’s “Three Represents” (which allowed capitalists into the CCP) and the 2001 accession to the WTO, neo-Maoists saw the betrayal of the PRC’s founding ideals. In the decade after its founding, Utopia expanded to become the most influential ideological watchdog in China. Its octo-pus-like reach extends into the organization of street marches, ideological study sessions, study trips to the Communist redoubts of North Korea and Cuba, and the sale and distribution of Marxist and Maoist books. It has publicly called for the sacking of China’s ex-premier Wen Jiabao, accused the CCP of betraying the Chinese people, advocated for war with Japan, congratulated North Korea on its nuclear tests, and launched violent cam-paigns against China’s liberal voices.

While Utopia attracts the most outside scrutiny and foreign media attention, it is only one of hundreds of websites and organizations that make up the broader movement. Some, like the website “Mao Flag,” offer venues for older CCP cadres to reminisce about the good old days before Deng Xiaoping rose to power and betrayed the revolution. Others


Jude Blanchette

can take a more confrontational tone: the website “Realizing Commu-nism” calls for aggressively rolling back market reforms, while the Weibo account “Ideological Battlefront” laments the unwillingness of neo-Mao-ists to take up armed struggle. Fortunately for Xi Jinping and the CCP, the more radical wings of the neo-Maoist movement have remained at the margins, while their establishment cousins work to bolster the authority of the “core” leader.

A neo-Maoist roadmap What unites all neo-Maoists, however, is a passionate belief that China has lost its ideological soul in the 40 years since Mao Zedong’s death and the rise of Deng Xiaoping’s policy of economic “Reform and Opening.” The very trends that the outside world celebrates—China’s accession to the WTO, its increasing openness to foreign capital, its dismantling of the state-owned economy—are precisely what they vehemently oppose.

What do the neo-Maoists want? First, they argue that the CCP should vigorously adhere to Article 1 of the country’s Constitution, which declares: “The socialist system is the basic system of the People’s Republic of China. Disruption of the socialist system by any organization or indi-vidual is prohibited.” Utopia argues that instead of following the Constitu-

tion, the CCP has over the past four decades abandoned its Maoist insti-tutions and ideals in favor of eco-nomic growth and neoliberal policy. In the words of Utopia co-found-er Zhang Hongliang, “[Reform and Opening have turned] 1.3bn Chi-nese people into slaves of GDP, into

slaves working for Western countries.” As the historian Xiao Gongqin has observed, “the radical Leftists attribute all China’s social maladies to what they term ‘the resurrection of capitalism’ in a nominally communist state. Their prescription is a second Cultural Revolution, a sweeping political movement that would uproot corruption and return the power to the masses, restoring social justice in the process.”

Second, neo-Maoists demand unwavering patriotism and loyalty from both the CCP and the Chinese people. This includes the rejection of West-ern “universal values,” which they believe are designed to weaken and ulti-mately subjugate the Chinese people. To the neo-Maoists, the enemies of the Chinese nation can be found in the country’s media, universities and government. Danger is also lurking in the foreign NGOs and companies

Utopia argues that the CCP has abandoned its Maoist institutions and ideals in favor of economic

growth and neoliberal policy


Politics

that work in China. These “hostile foreign forces” seek to profit off the backs of the Chinese people while simultaneously subverting the Chinese state.

Finally, groups like Utopia argue for a robust, militaristic nationalism. One frequent Utopia speaker, the Air Force Colonel Dai Xi, has written that Vietnam, Japan and the Philippines are “running dogs of the Unit-ed States in Asia,” and that China only needed to “kill one, and it will immediately bring the others to heel.” To Utopia and many neo-Maoist commentators, a strong PLA is needed to ensure that China never again suffers humiliation at the hands of foreign powers.

For Beijing, it’s Catch 22The size of the movement is difficult to estimate accurately, owing to its decentralized and opaque structure. Yet on multiple occasions the neo-Maoists have shown the extent of their reach: they have organized petitions garnering tens of thousands of signatures, and held frequent pro-tests. Given their pro-CCP bent, these are often allowed to be undertaken without official imposition. The neo-Maoists are also adept at using social media tools to spread their gospel and organize their forces, a develop-ment that has not gone unnoticed by the authorities.

The potential of the neo-Maoists for organized opposition raises the question: why does the CCP tolerate the neo-Maoists at all? Jia Xijin, a political scientist at Tsinghua University, believes that Utopia’s strident opposition to any ideas, groups or individuals who might bring about something akin to the Arab Spring in China “represents the opinions of many in government.” Several recent high-profile offensives initiated by the neo-Maoists to silence liberal intellectuals have undoubtedly displayed to Xi Jinping the utility of such a force. As Xi ramps up campaigns to revive the founding myths of the CCP, he will not find a more passionate ally than the neo-Maoists.

Yet there is a more fundamental reason why they are tolerated. As the CCP has embraced market reforms, the neo-Maoists have occupied the moral high ground. For the Party, an increasingly powerful left-wing flank brings with it the threat of de-legitimization. “Redder than thou” is a weapon that has been skillfully deployed by the neo-Maoist movement’s radical elements to challenge what they see as the “fake” Communist Party that rules the country. Thus the CCP finds itself in a Catch 22: crush the neo-Maoists and risk laying bare the Party’s abandonment of its socialist sympathies; allow them to operate untethered and risk a populist revolt.

While the strength of neo-Maoism undulates as it navigates the exi-gencies of the Chinese political system, there can be little doubt that the


Jude Blanchette

wellspring it draws support from is deep. Awed by the explosion of con-sumerist development—endless skyscrapers, five-star hotels and luxury cars—many outside observers ignored the upsurge of discontent that seethes just out of view, and the unique ability of Mao Zedong to offer many Chinese people an indigenous solution.

One can only imagine that Xi Jinping is watching the movement close-ly. Indeed, recent events demonstrate that Xi’s political sympathies align more closely with the neo-Maoists than previously thought. Certainly Xi

is no radical leftist populist, as many neo-Maoists are, but both share a visceral belief that the CCP should be ideologically pure as a prerequisite for unchallenged rule. Even before becoming general secretary of the CCP in November 2012, Xi indicated that the revival of Party orthodoxy

would be a central concern. As vice president, he made a point of visiting “red holy sites” such as Mao’s birthplace in Hunan province, declaring them to be “valuable treasures for our Party” that contained “rich political wis-dom and moral nutrients.” As the head of the CCP Party School beginning in 2007, Xi ratcheted-up the ideological requirements for enrolled cadres. In 2011, he told an assembly of students: “Cadres must seriously study Marxist theory to ensure that they can maintain political resoluteness.”

These early signs of ideological alignment have been strengthened since 2012. In addition to shuttering Yanhuang Chunqiu and the Unirule Institute, the bête noire of the neo-Maoist movement, a new provision was added to the recently-passed General Provisions of the Civil Law which would make it illegal to “harm the name, portrait, reputation and honor of heroes and martyrs.” Such an amendment has been a central concern of neo-Maoists for years, as they see the defamation of their CCP forebears as a concerted effort by hostile forces to undercut Party authority.

Taming the neo-Maoist tigersThe relative lack of progress on liberalizing economic reforms, not to mention Xi’s recent and repeated calls for greater Party oversight of SOEs, are a strong indication to the neo-Maoists that Xi agrees with their concerns of capitalist infiltration. On the international front, the recent aggressiveness of the Chinese military in defending territorial claims is likewise an unmistakable signal to the neo-Maoists that Xi shares their goal of ensuring the Chinese people are never again humiliated. So long as

Both Xi and the neo-Maoists share a visceral belief that the CCP should be ideologically pure as a

prerequisite for unchallenged rule


Politics

Xi continues to ensure that China remains a “red nation,” the neo-Maoists stand as his strongest allies, ready and willing to police Party orthodoxy in the online sphere. The price of speaking ill of Mao Zedong and the CCP has risen extensively since Xi came to power, in large measure a result of neo-Maoist online activism.

At the same time, neo-Maoists also represent Xi’s only potentially orga-nized opposition, should he eventually adhere to his 2013 Third Plenum pledge to institute far-reaching economic reforms. If, for example, Xi declared his intention to undertake economically necessary but politically controversial reforms to weaken the state’s grip on industry and services, his most vocal opposition would undoubtedly come from the neo-Maoists.

Xi’s relative permissiveness of the neo-Maoists, in stark contrast to his harsh treatment of more liberal groups, hints strongly at his latent approv-al of them. If he can find a way to co-opt the more radical elements of the neo-Maoist movement, then he will have placated the only serious grass-roots opposition that he faces. But this will not be easy, because the very red ideals the neo-Maoists uphold—equality, fairness, justice—are exactly those to which China’s leaders officially claim allegiance.


Its return to China was greeted with cautious optimism, but Hong Kong’s past 20 years have disappointed. Tepid growth

amplified inequality and bred political dissatisfaction. What happened since 1997? And what can we expect

for the future?

The years leading up to its return to China in 1997 were a golden era for Hong Kong. Its economy, driven by China’s opening to the world, kept growing relentlessly. Goods transiting through the city from south China made its port the world’s busiest in 1993. That same year, its per-capita GDP even overtook that of the UK, its colonial master. As the British prepared to depart, Hongkongers had their political concerns, of course: memories of the Tiananmen Square massacre were still fresh in many people’s minds. But offsetting them were hopes that prosperity would keep rising fast. Opinion polls showed people to be broadly optimistic about the future.

Yet since 1997, Hong Kong’s star has faded. Economic growth has slowed sharply. The city’s political divisions, between its pro-Beijing establishment and its pro-democracy opposition, have deepened. What happened over the past 20 years? And can anything be done about it?

Hong-Kong’s post-handover optimism did not last long. Just two days after Beijing resumed control, Thailand devalued its baht, kicking off the Asian financial crisis. The following year, Hong Kong had its first reces-sion in more than 50 years. The downturn was hardly the city’s fault. Its

Simon Cartledge is the owner of Big Brains, a Hong Kong-based research and publishing company, and the author of A System Apart: Hong Kong’s Political Economy from 1997 Until Now, to be published in July by Penguin.

Society

Whatever Happened To Hong Kong?By Simon Cartledge


Society

economy suffered from none of the problems that sent economies crash-ing across the region—principally large US dollar borrowings that proved impossible to repay when currencies devalued. So when Hong Kong recovered with GDP growth of nearly 8% in 2000, it seemed that it was just going through another of the many sharp rises and falls that its open economy had experienced in the previous five decades.

Post-crash bluesThat recovery, however, proved short-lived. The following years saw another downturn, following the bursting of the dotcom bubble and the severe acute respiratory syndrome (SARS) outbreak, and a second reces-sion, after the global financial crisis. Though Hong Kong bounced back after each of these shocks, the bounces were never as high as they had been from the 1960s to the 1980s. Gradually it became apparent that the pre-1997 growth rates—9% in the 1970s, more than 7% of the 1980s and 5% from 1990 to 1997—were not returning. From the handover to 2011, the economy expanded by an annual average of 3.6%, and slowed down again since to 1.9% in 2016.

Though far from disastrous, Hong Kong’s performance is disappoint-ing. Singapore, its great regional rival, has surged ahead since its 1997 dip, and now has a per-capita GDP a full 25% higher. South Korea, another economy hit badly by the Asian financial crisis, has closed the gap on


Simon Cartledge

Hong Kong. As has China: in 1997, the mainland’s economy was just eight times bigger than Hong Kong’s; now it is around 35 times larger. Even the UK regained its lead in terms of GDP per capita in 1998, and has stayed ahead ever since.

More inequality, more anger Accompanying Hong Kong’s economic slowdown was a reshuffling of economic gains. During the go-go years of the 1980s to the mid-1990s, the rising tide lifted all boats. Across the board, wages soared. But as the chart above shows, the Asian financial crisis changed all that. In the 15 years from 1997, Hong Kong’s poorest saw almost no change in their income, while its affluent citizens reaped most of the value created. Hong Kong’s already high degree of inequality increased further.

This happened despite government attempts to foster growth of the city’s middle classes by investing heavily in education. The number of universities in Hong Kong rose from two in 1990 to six by 1994. Another four were created after 1997. Today nearly a third of the workforce has a university degree, up from less than a tenth in 1994. Yet slower econom-ic growth has left many of these graduates struggling to find work that matches their qualifications. According to the government, more than one-fifth of the 854,000 graduates who entered the work force between 1994 and 2015 could not find graduate-level jobs. This oversupply also


Society

pushed down graduates’ salaries. By their late 20s, graduates born in the early 1980s had real median monthly earnings of 20% less than those born a decade earlier, at a similar stage in their working lives.

By the 2010s, discontent was widespread in Hong Kong, especially among those under 40. Not only did they have worse current earnings and future prospects than their predecessors, but they also faced contin-uously rising property prices making it harder and harder to buy a home, and growing disruption from the increasing number of visitors from mainland China. What is more, the government was clearly unwilling to pursue any form of political reform that might upset Beijing. In any case, the traditional pro-democracy opposition had no leverage. Perceptions were widespread that Hong Kong’s freedoms and way of life were slowly eroding. In 2014, this discontent spilled over into the Occupy movement, and in 2016 it resulted in the nearly one-fifth of the vote going to localist candidates in legislative elections.

Crony-state capitalismThe biggest barrier to change over the past 20 years has been Hong Kong’s constitutional arrangements, as set out in its mini-constitution the Basic Law. Drafted in 1990, the law was aimed at maintaining Hong Kong’s executive-driven, business-friendly political system. Its promises included allowing Hong Kong to keep both its capitalist economy and a high degree of autonomy. Unlike the British, how-ever, who simply installed the city’s governor with no consultation with Hong Kong, Beijing put in place a more complex system for choosing its chief executive, based on a selection committee. Two groups dominate the committee: organizations and individuals directly or indirectly answer-able to Beijing, accounting for two-thirds of members, and business inter-ests, making up the rest. This setup grants Beijing control over who can become chief executive. It also gives Hong Kong’s business establishment direct access to the heart of power.

The latter has allowed a small number of established companies—espe-cially those with property interests—to maintain a cozy control over key sectors of the economy, stifling competition and holding back change. For example, soon after the handover, Hong Kong’s first chief executive was unable to launch a much-needed home-building program. The city’s pub-lic housing construction arm has since been shuttered, and public policies

The biggest barrier to change over the past 20 years has been Hong

Kong’s constitutional arrangements


Simon Cartledge

have played to keep property prices high by restricting government land sales. Moreover, this institutional setting caused decades of foot-dragging before Hong Kong finally got a competition law in 2015. It also contrib-uted to the failure of a tax reform that, by broadening the government’s sources of revenues, would have lessened its reliance on property-related income and made property reform easier.

As a result, Hong Kong—which from the 1960s to the 1980s had become famous as a place where entrepreneurs could earn extraordinary fortunes by building giant companies—has seen no new major entrepreneur estab-lish him- or herself since; nor has it seen a single new industry emerge. At the handover, the city’s shift to being an almost totally services-based economy was largely complete, with three industries dominating: trading and logistics (25% of GDP), financial services (10%) and professional ser-vices (10%). By 2015, these remained the three main sectors: trading and logistics had declined slightly to 22%, financial services had risen to 18%, and professional services stood at 12%.

None of these sectors managed to create a strong and sustained eco-nomic impetus for the city; nor did China’s extraordinary transformation. Trading and logistics’ high share of GDP had reflected Hong Kong’s role as an intermediary between China and the rest of the world. In 2003, however, the city lost its crown as the world’s biggest container port to Shanghai, and since then has been overtaken by Singapore, Shenzhen and Ningbo. The fast-paced development of financial services was for its part very uneven. The increase in terms of GDP share was not accompanied by a similar rise in terms of employment. In 2015, the sector employed just 6.5% of the work force, up less than 1 pp from 5.6% in 1998. And though the government touted tourism as a fourth “pillar” industry from the mid-2000s onwards, it only accounted for 5% of GDP in 2015. While employing 7.2% of the city’s workforce, it did so mostly in lower-paying positions—to tour guides herding ever-larger groups of mainland visitors.

Twenty-year itchThere is much irony in Hong Kong’s predicament. Since 1997, a pro-busi-ness constitution has made Hong Kong less economically dynamic, while three pro-Beijing leaders have left it more wary of the rest of China. In 1997, almost everyone expected Hong Kong and the mainland to con-verge, but instead the two sides have moved apart.

This wasn’t inevitable. During the first decade after the handover, peo-ple in Hong Kong identified more and more as Chinese. Around 2008, however, that trend reversed. No single factor caused that change; rather


Society

it was the accumulation of a decade of slow growth, falling social mobility, rising inequality, deepening resentment of incoming mainlanders, and zero movement towards having a directly elected chief executive. It is hard to see the incoming chief executive, Carrie Lam Cheng Yuet-ngor, doing much to address these issues. She secured the post despite being clearly reluctant to take on the job and with a negligible policy platform.

Recent months have seen mainland officials adopt a harder line towards Hong Kong, repeatedly stressing the conditional nature of its high degree of autonomy. Leung’s administration launched a series of lawsuits against several opposition legislators aimed at removing them from office. Opposition figures have responded by declaring that Hong Kong’s values and identity are being eroded.

It is still too early to see how this will play out. Beijing appears to hold the stronger hand, yet its efforts at integrating Hong Kong with the rest of the country over the last decade have failed. The people of Hong Kong, though no nearer the universal suffrage promised them in the Basic Law, still enjoy broadly the same way of life they had in 1997. Hong Kong’s tycoons and their companies enjoy nothing like the respect they did two decades ago, and nor does the government.

The easy option is to suggest that Hong Kong will slowly continue to fade. Not to the extent of becoming just another of the many cities dotting China’s southern coast, but to the point where it is a shadow of


Simon Cartledge

its former self. Yet the surprises of the last 20 years—the protests that led to Tung’s downfall, Tsang’s imprisonment, and the rise of a generation demanding greater political autonomy—point to the possibility of a more unpredictable future. Much will depend on China’s trajectory. But a city that reinvented itself on several occasions under colonial rule, and which has proved tricky to run since its return to China, might not be a place to bet against.


Easternization: Asia’s Rise and America’s Decline by Gideon Rachman (Other Press, 2016)

The End of the Asian Century: War, Stagnation, and the Risks to the World’s Most Dynamic Region

by Michael Auslin (Yale University Press, 2017)

The eastward shift in the center of the world’s gravity is a familiar idea, and one that becomes ever-more compelling. By 2025, two-thirds of the global population will live in Asia, which is already home to two of the world’s three biggest economies—or three of the top four in purchasing parity terms. According to the CIA’s forecasts, “by 2030 Asia will have surpassed North America and Europe combined in terms of global power, based upon GDP, population size, military spending and technological investment.” With the United States retreating from its international role under President Trump, Xi Jinping is eyeing the baton of global leadership.

This is the theme addressed by Gideon Rachman, the Financial Times’ chief foreign affairs commentator, in Easternization: Asia’s Rise and America’s Decline. In a broad and lucid survey of international relations, he contends that the Asia-Pacific region will shape global politics and economics in the 21st Century, as the West’s centuries-long domination of world affairs draws to a close. Asia’s growing economic brawn is enabling it to catch up militarily and technologically, which will naturally translate into geopolitical might. This “shift of power and wealth from the West to Asia” is not just about the rise of China: with its population set to overtake China’s by 2022, India is on course to follow a similar path.

Tom Miller is managing editor of the China Economic Quarterly.

Books

The East Is Rising … Isn’t It?

By Tom Miller


Tom Miller

Asia will need to overcome political problems, of course, especially cor-ruption at home and rivalries abroad. Territorial disputes are unavoidable. But these will not change the broader geopolitical picture, Rachman avers, noting the episodes of extreme instability that accompanied the West’s own rise. Not even a pronounced slowdown in Chinese growth or regional military conflict is likely to thwart the Asian juggernaut: “The economic development that allows China and India to push for great-power status has already happened.” Here Rachman presses his case too far: India, for one, is still a decade or two from becoming a great power. But his basic case is sound.

How will the West—especially the US, the incumbent superpower—react? The old argument over whether the US should seek to contain China or accommodate it continues to play out in Washington, DC. But Rachman believes all US leaders will struggle to resist the historical force of Easternization, which is beyond their control. He is sympathetic to President Obama, whose “pivot to Asia” was warmly greeted by Asian countries seeking a counterbalance to China, but which fizzled out as US attention turned to the Middle East. Even if President Trump decides that making America great again requires a stronger presence in the Asia-Pa-cific, he will struggle to win the unquestioned support of Southeast Asian countries, which are keen to hedge their bets between the two superpow-ers.

“Realists” argue that conflict in Asia is likely, as China’s vast economy and growing military power mean that it will inevitably seek to dominate the region. Rachman argues that the strength of regional support for a continued strong US role “makes America’s determination to push back against Chinese hegemony both morally defensible and strategically feasi-ble.” With Japan, India and Australia on board, the Thucydides Trap—the logic that a rising power is destined to go to war with the established power—will not necessarily spring. And he suggests that the strength of Western institutions, especially the power of the dollar and the rule of law, ensure that “even as the global economy Easternizes, much of the world’s wiring still runs through the West.”

Don’t believe the hype This is a conclusion with which Michael Auslin, a resident scholar at the American Enterprise Institute for Public Policy Research, would certainly agree. But the thrust of his argument in The End of the Asian Century: War, Stagnation, and the Risks to the World’s Most Dynamic Region is the opposite of Rachman’s. Asia, he says, is “riddled with unseen threats, from


Books

economic stagnation to political unrest and growing military tensions” that may scupper the process of Easternization. He stresses that he is merely assessing risk, not making predictions about Asia’s collapse. But far from viewing it as an engine of global growth, he views Asia as a danger-ous source of potential conflict and instability.

Auslin’s provocatively titled book has garnered praise from the great and the good of American public life. Former US Treasury secretary Larry Summers, to quote one such luminary, called it “A powerful antidote to the Asiaphoria that dominates conventional wisdom.” The book proposes the interesting idea of a “risk map,” which boils down to five threats to Asia’s rise: 1) failure of economic reform, 2) demographic pressure, 3) unfinished political revolutions, 4) lack of regional political community, and 5) the threat of war. In princi-ple, his argument is a useful corrective to some of the guff written about Asia’s—and, in particular—China’s inevitable rise. But The End of the Asian Century is, sadly, a missed opportunity: poorly written in places, weakly argued, and offering few fresh insights.

Auslin is especially weak on China, which he clearly doesn’t know well. His survey of the economy is superficial, relying on old data cobbled togeth-er from dozens of secondhand sources. When he moves on to politics, we hear that the Communist Party is “distrusted and disliked by the vast major-ity of the population,” without any evidence to back this up. He talks about “anti-Party protests”—actually usually aimed at local government officials. The wide-eyed descriptions of China are embarrassing. “[P]erhaps the most noticeable aspect of modernization,” he writes, “is that China’s tens of millions of bicycles have been replaced by automobiles.” The vignettes from his travels across Asia are equally vacuous, sometimes slipping into cliché. “India,” inevitably, “is an assault on the senses.”

How to save AsiaAuslin is better when he stops pretending to be a journalist and knuckles down to security issues. He outlines how the Asia-Pacific has become the most militarized region in the world, with four official nuclear powers and an undeclared nuclear state in North Korea, not to mention six of the world’s most powerful armed forces. The US’s military presence in the region has helped maintain a reasonably secure environment for most of the past six decades, bolstered by security treaties with Australia, the Phil-

US leaders will struggle to resist the historical force of Easternization,

which is beyond their control


Tom Miller

ippines, South Korea, Thailand and Japan. The US maintains 360,000 per-sonnel in the Pacific along with nearly 100 ships and hundreds of planes, from fighter jets to bombers. But Beijing is spending heavily on its own military, especially its navy, which is upsetting the political and military equilibrium. This has resulted in a regional arms race.

What should be done to avert the threat of war? Auslin’s solution, deliv-ered in an unremittingly prescriptive tone, is quaintly old-fashioned. The US and other liberal nations need to forge closer security ties and promote regional democracy. “Updating Washington’s half-century-old alliance system, promoting a community of liberal interests, and further tying the American economy to Asia’s through free trade will deepen our leverage and enhance our stake in the region,” he preaches. In short, it is America’s job to make the East look more like the West. In itself, this is a perfectly reasonable strategy—albeit one that has often failed in past. Whether Donald Trump agrees, or even cares, is another matter.

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