Geopolitics with Chinese Characteristics

That China is the Asian Development Bank's largest recipient of Bank funds really is scandalous, and comes at the cost of countries like Bangladesh and Nepal, the poorest of the poor, which truly need the resources.
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The emergence of a new power has often profoundly shifted the geopolitical landscape and caused considerable discomfort among the established order. China's current economic and political resurgence is doing that, but apart from the inevitable uncertainty and tension associated with any shift in global power, much of the angst in China's case stems from its failure to engage in behavior concomitant with its increased global responsibilities -- or even to acknowledge an obligation to do so.

China's rise may be unique, for it has ascended rapidly onto the global stage by virtue of its total economic might even as it retains characteristics of a developing country by GDP per capita. China seems to want it both ways -- it plays geopolitical power games as a force to be reckoned with among equals, yet declines to shoulder the burdens of a great power, or even demands to be afforded the benefits due to an underdeveloped charity case. In this regard, China's leadership often appears schizophrenic, nursing a profound grievance against "colonialists" and "aggressors" as it expands its direct political and economic influence across the globe. China's rulers show bravado when on the world stage, but seem deeply paranoid that their rule at home could all fall apart at any time.

While China's public pronouncements may at times appear mercurial, they are more likely part of a well-conceived strategy. On one hand, China seeks to leverage benefits consistent with being a developing country, plays upon the west's historical guilt over colonialism, and exploits the west's continued belief that economic development will inexorably lead to pluralism. On the other hand, it does not hesitate to attempt to parlay its growing power into influence whenever and wherever it can. This Janus-like strategy gives China leeway and flexibility in crafting its international political and economic policy.

At home, the Chinese Communist Party (CCP) has established Socialism with Chinese characteristics, or, less euphemistically, state capitalism. State capitalism typically involves state powers using markets to create wealth, while ensuring political survival of the ruling class. As a government that now presides over the third (soon to be second) largest economy in the world -- and one that depends intimately on flows of international goods and capital -- the CCP no longer simply practices state capitalism at home: it applies it globally.

Although the west has long played mercantilist games, it has gradually migrated toward the belief that liberalization of international markets is mutually beneficial for all countries. But China continues to see international economics as a zero-sum game. It finds its developing status a convenient cloak and justification for the application of global state capitalism. It engages in beggar-thy-neighbor policies it deems advantageous, and distorts the world's markets according to the dictates of its political demands, while dismissing criticism of such behavior as unfair to a developing country. Similarly, on political issues, China portrays naked self interest as the reasonable demands of a developing country, and displays this behavior in nearly every arena in which it interacts with the world, from foreign aid and investment to multilateral institutions to international relations.

The undervaluation of the yuan is worth reviewing as a representative case, and points to further distortions of international markets by China's state capitalism. The Peterson Institute for International Economics estimates that the yuan is undervalued by between 20 and 40 percent, amounting to a massive export subsidy. However, the yuan's undervaluation may be the tip of the iceberg. As importantly, Chinese banks receive a hidden subsidy: a wide spread between the rates paid on household deposits and the rates banks charge for loans. Bankers, who are in effect state employees -- given that the banking system is largely government run -- funnel the artificially cheap money to state-owned enterprises (SOEs). Since households have no investment alternative to domestic banks, they in effect provide a huge subsidy to Chinese industry.

The CCP's state capitalism mandates growth and employment through exports and investment at all costs in order to ensure its political supremacy. One price of this systemic export subsidy is the distortion of the domestic economy in favor of export-dependent growth. Another, of course, is the distortion of the global economy resulting from China's $1.4 trillion in estimated exports this year, combined with foreign exchange reserves which will approach $3 trillion this year. Yet China refuses to acknowledge there is a serious problem. Premier Wen Jiabao recently praised the yuan's stability as "an important contribution" to global recovery, and added, "I don't think the yuan is undervalued." Wen then played his rhetorical trump card, alleging that developed countries were seeking to force unfair currency changes "just for the purposes of increasing their own exports." Wen provides insight into China's strategy when it faces legitimate international criticism by first denying that its state capitalism distorts markets (and therefore, that it is playing by different rules of the game than the west), and second, by obfuscating the issue, depicting it as one of developed countries picking on developing countries.

Even as China increases its economic presence through investment and greater influence in multilateral institutions, it continues to reap benefits intended to accrue to the world's truly needy nations. By all rights, China should be a donor nation in multilateral development banks, not a recipient of aid. That China is the Asian Development Bank's largest recipient of Bank funds really is scandalous, and comes at the cost of countries like Bangladesh and Nepal, the poorest of the poor, which truly need the resources. As of 2007, China was ranked in the top 15 of development aid recipients worldwide. But in late April of 2010, China increased its number of voting shares in the World Bank to become the third largest stakeholder, behind the U.S. and Japan. The U.S. and Japan do not receive development assistance from organizations like the World Bank -- at what point does China's absolute strength count for more than its per capita development? And why should donor countries like the U.S. and Japan allow this double standard to occur?

China continues to expand its own program of foreign aid, dubbed official development assistance (ODA), which is closely linked to its outward foreign direct investment (OFDI). Because of the scale of its ODA and OFDI, the two combine as an effective instrument of state policy. This is really no different than how foreign assistance and FDI are deployed by a plethora of other countries - such as Japan - but China's tendency is to 'bulldoze' its way into developing countries, providing cash and assistance in order to secure natural resources. China has closely dovetailed ODA with its OFDI, offering infrastructure projects, soft loans, debt relief, and grants as a package deal to resource rich countries. This projection of Chinese state power, and the frequent result (such as a tendency not to hire locals to complete construction projects and a failure to transfer knowledge from China to the recipient nation) has had negative consequences for recipient nations.

China's OFDI is relatively small, but growing at one of the fastest rates in the world. In 2008, OFDI stock amounted to just 3.5% of GDP. Since officially launching its "go global" program in 2001, China has pushed its OFDI growth rate to 116% annually from 2000-2006, compared to the average global growth rate of 6% over the same period. SOEs dominate OFDI, and more than half operate in the natural resources sector. In 2006, the top three OFDI investors were China Petrochemical Corporation (Sinopec), China National Petroleum Corporation (CNPC), and China National Offshore Oil Corporation (CNOOC). Strategic service sector investments to support export and import activity, such as shipping and insurance, account for the largest portion of OFDI to date. The lion's share of Chinese OFDI represents a strategic investment; acquiring firms and footholds in strategic markets and guaranteeing access to commodities necessary to fuel the country's export-oriented economy being the overriding objectives.

Politically, China is an irredentist power that arguably has done more to advance global nuclear proliferation than any other state save Pakistan, while routinely doing business with some of the world's worst governments. Apart from the issues of Taiwan and the Spratly Islands, China lays claim to much of India's state of Arunachal Pradesh, and caused major jitters in 2009 with incursions into the territory combined with strident rhetoric. It has blocked Asian Development Bank projects approved for India over the issue. It helped Pakistan develop its nuclear arsenal and ballistic missile technology. Currently, the largest recipients of Chinese military aid are India's neighbors, including Burma, Pakistan, Nepal, Bangladesh, and Sri Lanka in addition to Pakistan; India fears that China is engaged in a concerted campaign to undermine and contain it. In addition, China is rapidly developing its "string of pearls" strategy in the Indian Ocean, investing significant resources to develop deep water ports in the Bay of Bengal, the Arabian Sea, Pakistan, Sri Lanka, and the Seychelles. These appear to be a basis for the projection of a powerful naval presence into what India considers its backyard.

Meanwhile, China blocks action against or actively supports a rogue's gallery of nations, among them Iran, North Korea, Sudan, and Zimbabwe. It claims it has no influence over their actions, based on its policy of non-interference, but China's support clearly requires a quid pro quo, be it natural resource wealth, business ties, or a geopolitically strategic use. China has avoided sanctions from the international community, partly due to the image it has cultivated of itself as a non-interfering developing country. While the west has also projected its power and dealt with equally noxious states, domestic political constraints make such "deals with the devil" increasingly difficult to sell to an electorate attuned to human rights, ethics, and governance.

As long as the CCP continues to govern, China will not change. It will continue to comport itself according to its zero sum vision of the world. At best, the west can hope the CCP's interests converge toward those of the larger globalized world. For the moment, even as China speaks of a peaceful rise within the existing international structure, its behavior, which at times may only be described as ruthless, belies the west's faith in its words. Indeed, the west appears to be running out of patience at China's uncompromising approach to the promotion of its own self interest. President Obama has attempted to engage China on a variety of global issues, and for the most part found that his proffered hand was met with a clenched fist. The U.S. may soon discard the illusion that China is gradually transitioning to become a responsible global power and may begin to react to China in a manner consistent with what it really is: an emerging global superpower that will stop at nothing to promote its own interests.

Stephen Goldsmith is an analyst with the International Country Risk Guide. Daniel Wagner is Managing Director of Country Risk Solutions, a Connecticut-based political and economic risk consultancy.

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