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I’ve recently returned from
Asia, where I met with policy makers and business leaders from Tokyo to
Beijing, Hong Kong, and Singapore.
During our discussions, I was
repeatedly struck by how often the conversation would veer from economic
analysis into the realm of geostrategy, especially with respect to China’s
emergence as a major military power—or, as it is known in polite geopolitical
circles, the peaceful rise of China.
As the most populous nation
on earth, and the world’s second-largest economy, China is increasingly
becoming both a concern and an opportunity for investors. (As an example of
China’s influence on the global economy, a recent analysis by The Economist tied more
than 10% of American multinational corporate revenue to China.)
A 4,000-year-old culture has
begun to reassert itself on the world stage, and investors should arm
themselves with a bit of knowledge of the powerful forces at play there.
My
goal is to lay a foundation for that understanding.
The concept of a “peaceful
rise” is, perhaps, the triumph of hope over experience. During the last hundred
years, the rise of great powers has been anything but peaceful: Historically,
when a great power rises, there has been an elevated risk of territorial
expansion, imperial aggression, and even the looming threat of world war.
In the case of China, the
goal of this peaceful rise is to avoid the fate that has seized other emergent
powers, such as the Empire of Japan during the Second World War, and Germany
during World War I and World War II.
China has already begun to
develop its own blue-water navy, capable of operating in vast expanses of open
ocean. The South China Sea, which borders China’s east coast to the south, is
crowded with islands. Maintaining security in those shipping lanes is of
paramount importance to the Chinese leadership.
More than half of global
merchant tonnage, and four-fifths of the oil burned in China, pass through the
South China Sea. Clearly, the defense of those shipping lanes is critical not
just to China’s economic development, but also to Chinese national security.
An especially important
strategic concern in the South China Sea is the security of the Strait of
Malacca, a narrow, 500-mile passage between the Malay Peninsula and the island
of Sumatra, which serves as the primary point of entry for cargo bound for East
Asia.
Whenever I fly into
Singapore, I always watch from the window. As the plane begins its descent, you
get a bird's-eye view of the strait below, which looks like an endless ribbon
of deep blue water, crowded with thousands of cargo ships.
Strait of Malacca on January 21, 2013. (leogaggl/Flickr)
Strait of Malacca on January 21, 2013. (leogaggl/Flickr)
There are good reasons to be
hopeful that China’s rise will be a peaceful one, avoiding the aggression and
the terrible conflicts that have followed other rising powers. Of course, a
“peaceful rise” must entail the absence of war, but what, beyond avoiding
military catastrophe, would success in China look like? Let’s take a look at
the long-term risks and opportunities in today’s China.
Roadmap for a
Successful Rise
One way to think about the
challenges of China’s emergence as a great power is to look at the best-case
scenario for a rising China.
First, in geopolitics, a
stable China must seek to limit its territorial ambition. The Chinese
government must find ways to resolve their current regional-territorial
disputes, including the long-simmering conflict with Japan over the disputed
Senkaku Islands in the East China Sea. On the other side, the US pivot to Asia
should not be designed and perceived as a way to contain China.
Second, on the economic
front, China and its regional trading partners must improve trade and financial
integration, and increase foreign direct investment among all parties. The US
may need to allow China to join the trade-liberalizing Trans Pacific
Partnership (TPP), as excluding China may signal that the US pivot to Asia is
to counter the rise of China.
Third, China needs to
successfully implement its transition from credit-fueled, resource-intensive,
highly polluting, capital-intensive growth based on too many investments in
real estate, infrastructure, and industrial capacity to labor-intensive,
environmentally friendly growth based on consumption and the rise of services.
So far, the reforms needed to
achieve this rebalancing have been postponed as President Xi is busy with
consolidating his power, cracking down on corruption, and dealing with foreign
policy and security issues. But the longer China kicks the can down the road
and postpones reforms, the greater is the risk of a hard landing as bad assets,
bad investments, and bad debts are mounting.
Ultimately, one would hope to
see an easing of diplomatic tension, which would help to create a broader peace
and prosperity in Asia. The APEC summit that took place while I was in Beijing
in early November is an opportunity to start a dialogue on economic and geopolitical
security in Asia.
I recently read an intriguing
new book by reporter and analyst Robert Kaplan, which addresses the topic of
China’s rise. In Asia’s
Cauldron, Kaplan makes a compelling case for a kind of geographic
determinism in Asia with respect to a rising China.
The backbone of Kaplan’s
argument is that a rising China will seek to dominate the South China Sea in a
manner similar to the way that the United States sought to dominate the
Caribbean in the 19th and early 20th centuries. (In practice, Teddy Roosevelt’s
policy of “Speak softly and carry a big stick” often meant fighting wars,
changing the regimes of Caribbean governments, and militarily overseeing
trade.)
But geography doesn’t need to
be destiny, the way Kaplan mechanistically implies. The Pacific stance of the
US, the existence of other important powers—such as Japan, other allies of the
US, and India—that will resist Chinese expansionism may lead to a more
cooperative outcome for the geopolitical balance of Asia.
I mentioned the Strait of
Malacca earlier, and China’s build-up of a blue-water navy to ensure its access
to shipping lanes there and elsewhere. As a matter of international law, the
Chinese have no territorial rights to the strait. (The strait lies hundreds of
miles to the south of mainland China, on the far side of Thailand, Cambodia,
and Vietnam, between the island nations of Malaysia and Indonesia.) However,
the waterway is clearly vital to China’s national interests and crucial to its
economy.
In addition
to those questions posed by the region’s geography, there is also the issue of
China’s ideology. Or, perhaps more accurately stated, China’s absence of a
Soviet-style grand ideology. The current Chinese leadership doesn’t seem
interested in philosophical debate about economic philosophy: Their focus lies
on pragmatic questions of competition for power and influence. While this may
be something of a negative insight, it may prove to be a useful conceptual lens
for investors to view China’s rising economic power.
The Role of the United
States
In the short to medium term,
the United States is almost certain to maintain its naval superiority in the
Pacific region. (The US now has 10 aircraft carriers in its fleet. China has
only one—and it’s an obsolete, secondhand vessel at that.)
Over the longer term,
however, China will continue to make steady advances in ballistic missiles and
other military technologies, potentially allowing its navy to one day pose a
significant strategic challenge to the US in the Asia-Pacific region.
Diplomatically, the West has
a delicate balancing act to maintain in its relations with China.
If Beijing perceives that
China has become the target of a US containment policy, similar to the policy
by which the West sought to isolate the Soviet Union during the Cold War, the
Chinese would likely interpret this policy as an act of aggression. It is
equally dangerous for the West to assume a posture of mechanical appeasement,
deferring to too many of China’s economic and diplomatic demands.
The Chinese leadership, if it
were to meet with such a permissive policy, might be inclined to stretch toward
evermore territorial ambitions. So, the US and its allies in Asia need to find
a right balance between cooperation and competition with China and avoid both
containment and unconditional appeasement.
What’s in the Air?
Beijing is ringed by
coal-fired power plants and heavy industry—unseen sources of the smog that
choke China’s capital. Coal, quite literally, fuels China’s industrial
growth—accounting for nearly 70% of its total energy production.
When you drive around the
city of Beijing, you can see people on the street wearing surgical masks, or
with scarves covering their nose and mouth to try to reduce the pollution they
are forced to inhale. The situation is so severe that the Chinese government
continually monitors the count of particles in the air. On some days, when the
particle count is particularly high, cars are banned from the city.
When the number rises above
100, it’s considered dangerous. When I was in Beijing, the readings were at
300. However, my hosts assured me that things weren’t so bad—since the
particulate count had recently risen as alarmingly high as 550. Paradoxically,
the carbon emissions that have fueled China’s ascent may prove to be one of the
biggest challenges to China’s peaceful rise.
Some Beijing residents have
attempted to fight back against the pollution by installing air filtration
systems in their homes and offices, but this option is only available to those
with the financial means to do so. Similarly, the city’s priciest private schools
have air filtration systems and covered gyms, allowing students to play without
being exposed to the outside air, although most schools can’t afford such
accommodations.
Chinese officials often talk
about the need to stress quality over quantity when it comes to economic
growth—but when you’re on the ground in China, you don’t see much of a shift in
the country’s development strategy. Air, water, and land are all polluted, with
serious risks to the safety of the food chain. Health costs from environmental damage
could seriously strain the Chinese budget for decades to come. (Perhaps this
isn’t surprising: It’s easier for an official from the Ministry of Commerce to
make a speech than it is to reduce carbon emissions in a rapidly developing
economy.)
In any case, the pollution is
now so severe that it’s creating a political backlash by a rising middle class
against the Chinese leadership, for obvious reasons.
The challenges of pollution
within China are, of course, not limited to Beijing. The pollution in Shanghai
is steadily getting worse. Expatriates working for multinational corporations
are becoming increasingly less willing to live in these cities, even though
their companies are offering progressively higher salaries to do so. Expats who
remain are, understandably, sending their families back home.
The problems of pollution are
no longer just a domestic issue for the Chinese. When I visited Korea, on my
way to China, there were Korean officials who complained that air pollution
from China was being carried into Seoul by the wind. Some studies now suggest
that Chinese pollution is traveling as far as Hawaii and even California.
China is the world’s largest
source of carbon emissions. If there is a silver lining to this toxic cloud, it
may be that China’s pollution crisis has forced it to search for green
alternatives to its coal addiction.
Several independent reports
in the last few years, including studies done by the United Nations, Pew
Research, and Bloomberg, have cited China’s investment in green energy as the
largest in the world.
Chinese government officials
have begun to tout green energy as part of their economic strategy. While the
environmental results of China’s green-energy policy remain to be seen, Chinese
investment in renewable energy is simply a fact, and one that investors
should consider.
Recent studies show global
investment in renewable energy production nearing a quarter of a trillion
dollars annually. China seems poised to remain a world leader in that
space—driven by political necessity, perhaps, more than deep environmental
conviction.
My Final Thoughts
In addition to being the
world’s second-largest overall economy, China is the largest economy in Asia.
From the perspective of investors, the size and scope of the Chinese economy
mean great potential for both risk and opportunity: the risk is more short term
as China needs to rebalance its economy and avoid a hard landing; while the
opportunity is medium and long term as China will—in a few years—become the
largest economy in the world and the largest market. A rising China is,
perhaps, the key center of gravity in developing Asia, which is now the
fastest-growing region of the world.
Under such circumstances,
it’s reasonable to assume that China will assert itself defensively—for example,
to maintain the security of vital international shipping lanes in the region.
Without the ability to defend
its trade routes, it would be possible for a regional rival to strangle China’s
economic growth, which is a proposition that neither the Chinese leadership nor
the broader population would be willing to accept. China will continue to
project its power in the region in a way that is consistent with its national
interest. And we will continue to watch their progress.
As I project forward to the
future of Asia in 10 or 20 years, I envision a China that will continue to
stretch its economic and international trading power. A China that will assert
itself more broadly in the political sphere. A China that will exert increasing
influence in its own geographic region. A China that will continue to project
its geopolitical power, as it rises to address the challenges of a great world
power in 21st-century Asia.
And, ultimately, a China that
will open a door to long-term opportunities for astute investors.
Cordially,
Nouriel Roubini
Chairman
Roubini's Edge
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