Thursday, December 8, 2011

Sino-US relations at vulnerable juncture; towards additional conflict instead of cooperation....

Sino-US relations at vulnerable juncture; towards additional conflict instead of cooperation....

By Benjamin A Shobert

The November release of the US-China Economic and Security Review Commission's (USCC) annual report on the state of US-Sino relations certainly covered its fair share of the traditional suspects. Spread throughout the report are numerous calls for action on the matter of the yuan valuation, the need for the US to more aggressively access the WTO as a means of addressing its grievances with China, and on the foreign affairs front, China's reticence to deal with North Korea and Iran in ways that America believes China should.

But this year's report is different in that the commission's 2011 report to congress takes place in the shadow of major power transitions in both China and the United States (which country's transition will be more orderly and productive is, of course, a matter of some dispute).

In the US, the 2012 presidential election will occur in November, while in China, the 18th National Congress of the Chinese Communist Party (CCP) will occur sometime in the autumn, during which time a new central committee, politburo and general secretary will be chosen.

Political forces have obviously always shaped US-Sino relations, but in 2012 the stakes are much higher for both countries. America's feeling of economic vulnerability is beginning to express itself with building intensity over what it feels is an unbalanced and unfair trade relationship with China. This frustration is slowly but surely acting to reinforce the opinions of those in Washington who believe that China should be seen less as a potential partner and more as a strategic competitor on both economic and military fronts.

Consequently, those who have in the past dismissed the findings of this commission as pure political posturing can not afford to any longer diminish the weight of congressional committee findings like those of the USCC's. Whatever lens through which outsiders may choose to interpret the USCC's 2011 report, it unmistakably captures and reflects a vibrant and increasingly influential line of thought about China from within the US Congress.

At the forefront of the 2011 USCC report are ongoing concerns over the role of China's state-owned enterprises (SOEs). As the report notes, the process of reforming China's domestic economy and the role of SOEs within it has, if anything, gone backwards over the last year.

The USCC points out that this reversal has been designed to, "creat[e] SOEs that dominate important portions of the economy, especially in the industrial sectors, reserved for the state's control". The USCC believes that this change in the direction can be largely understood as a perhaps unforeseen consequence of the massive 2008-2009 stimulus put through by Beijing.

This stimulus largely benefited China's SOEs at the expense of both China's privately owned companies as well as to the detriment of American and European companies who stood to potentially benefit if the stimulus money could be directed towards products and services they were capable of providing.

Quoting a 2010 World Trade Organization report on China's SOEs, the USSC report shares that "SOEs have been 'benefitting disproportionately from the [g]overnment's recent measures to boost the economy ... at the same time domestic private enterprises are finding it more difficult to access credits from banks." The net of this is, to quote many a Chinese entrepreneur, "the state advances, the private [sector] retreats."

How open Beijing is willing to be towards outside competition in sectors its SOEs currently dominate is not only a question related to economic reform; it also has implications for how American and European companies view the domestic Chinese market. Here the long-standing and much publicized Indigenous Innovation policies put forward by Beijing during its 2008-09 stimulus program continue to be a cause for concern.

Even though analysts have pointed out that much of what is written in the Indigenous Innovation policy was essentially putting down in writing what has been the unspoken reality on the ground in China for years, by codifying the practices, Beijing put a bulls-eye on an issue that most inside and outside the country knew would ultimately need to be dealt with.

Beijing has made gradual moves to neutralize some of the more draconian aspects of the Indigenous Innovation policy by relaxing the expectations that government procurement catalogs only feature domestic Chinese companies (or multinationals who had agreed to the technology transfer policy); however, as the USCC report notes, "the long effort by the central government ... is a message that will likely outlive any product catalogues."

What troubles the USCC is not only the policy itself, but also what it suggests about China's attitude towards the need for a healthy trade relationship with its partners. As the report notes, the policy "demonstrated the government's view that Chinese companies and governments are better off substituting domestic goods for imports".

USCC chairman William Reinsch said in opening remarks when the 2011 report was issued, "These policies are intended to discriminate against foreign goods and services and to substitute domestic goods, apparently as a device to force the transfer of technology to Chinese firms."

He then went on to state, "These policies, along with China's failure to provide adequate IP [intellectual property] protection, strike at the heart of America's greatest economic strength - its ability to innovate". Throughout the 2011 report, numerous instances are made towards China's strategy for moving up the manufacturing supply chain into higher value products coupled to "large swathes of the Chinese economy [being] closed off to foreign investors", a key structural challenge for the two countries.
By connecting technology transfer requirements to China's SOE sector, the USCC is drawing a clear line connecting the direction of China's economic reforms and its unwillingness to play by the rules with what the American economy must rely on to pull itself out of the current recession. Whether this is a fair criticism or a voice of suspicion related to American insecurities, there is no more powerful political narrative in Washington right now than the growing sense that China's entrance to the WTO has helped China bend the rules to its benefit and the general detriment of its trading partners.

Making note of the 10th anniversary of China's entry to the WTO in December, Reinsch noted that China's most recent strategies have been "contrary to the spirit, and in many cases the letter, of China's WTO commitments". The 2011 USCC report goes further, writing that "China has grown more assertive and creative in using WTO procedures to alleviate, eliminate, and avoid certain restrictions in the Accession Protocol."

China's autocratic tendencies are of concern not only in how it manages its domestic economy, but also in what the USCC report calls China's "internal dilemmas". Of note through the course of 2011 was not only a regression of hoped-for economic reforms, but also anticipated political changes. Frightened by the instability brought upon governments in the Middle East during the Arab Spring, Beijing acted to clamp down on any potential source of instability.

The report notes that in 2011, China acted to clamp down on Internet freedoms while spiriting away several high-profile political activists. Internet cafes are now being required to install software that obtains the user's information, making it easier for the government to track down dissenting voices that use the Internet to express their frustrations or opinions. Additionally, Beijing has "rescinded many of the freedoms that were granted to foreign reporters in the run-up to the Beijing Olympics". The hope that the Games would lead China to incrementally allow additional political dissent afterwards, has almost entirely dissolved.

This then appears to be the state of US-China relations as captured in the USCC's most recent report: economic and political reforms have not simply stalled, as was made the case in past years' reports. No, economic and political reforms have actually reversed direction over the past year, a finding that sets the stage very neatly for a US Congress looking for convenient political scapegoats and an American public increasingly frustrated over its domestic economy and equally suspicious over whether China might not be part of America's problems.

Neither of these are to suggest that China's reversal is good, or that nothing should be made as to what these changes might suggest about China's government. They point, as the report notes, to a government increasingly concerned over already wide and growing inequalities of income and access to services that hold the potential to destabilize the country.

What Beijing may not realize, or, to give its leaders some credit, what they may not agree with, is the timing of China's retrenchment and how it coincides with the country's militarization. How these three phenomena have aligned over the last twelve months is cause for concern because it brings together economic, political and national security concerns.

While 2011 did see China's first aircraft carrier launch and the first flight of its J-20 stealth fighter, the USCC notes that the more subtle change from a policy of access denial to what the Commission calls a policy of "area control". The change in language captures what the USCC believes is what the PLA is now positioning itself for, "to easily conduct operations against regional states".

This doctrinal adjustment represents a country that no longer believes its best strategy against American power will be purely to deny access to critical parts of its littorals. Now the People's Liberation Army (PLA) instead is preparing itself to be capable of forward projecting its power regionally.

None of this is to say China is preparing to act in this way, merely that the country's military planners are now developing strategies and weapons platforms capable of doing so should they feel it necessary to do so. Looking at the PLA's growing capabilities, the USSC report writes that "While US bases in East Asia are vulnerable to PLA air and missile attacks, Japanese, Philippine, and Vietnamese bases are just as vulnerable, if not more so."

At the end of the 2011 report, Commissioners Reinsch and Robin Cleveland make a final plea for those reading the USCC's findings to look beyond those issues the US may have with China and see those that lie within America's ability to change. As they both write, "This means that the right answers lie in policies we should pursue to make ourselves more competitive than policies to hold the Chinese back."

While admirable sentiments, the bulk of the 2011 report suggests that unless China and the United States can find a way to better balance their respective domestic economic and political needs against the weight of globalization and the changes it has brought with it, we may well be on the road towards additional conflict instead of cooperation in 2012 and beyond.

Benjamin A Shobert is the Managing Director of Rubicon Strategy Group.