China and the World : Balance, Imbalance and Rebalance [1 ed.] 9789004255845, 9789004255838

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China and the World

China in the World A Survey of Chinese Perspectives on International Politics and Economics Chief Editor

Shao Binhong

Chinese Academy of Social Sciences International Advisor

Allen Carlson

Cornell University

VOLUME 1

The titles published in this series are listed at brill.com/cwpe

China and the World Balance, Imbalance and Rebalance Edited by

Shao Binhong

Leiden • boston 2013

This book is the result of a co-publication agreement between Social Sciences Academic Press and Koninklijke Brill NV. This book is published with financial support from Innovation Project of the Chinese Academy of Social Sciences. Library of Congress Cataloging-in-Publication Data China and the world : balance, imbalance and rebalance / edited by Shao Binhong.  pages cm. — (China in the world : a survey of Chinese perspectives on international politics and economics ; volume 1)  Includes bibliographical references and index.  ISBN 978-90-04-25583-8 (hardback : alk. paper) — ISBN 978-90-04-25584-5 (e-book) 1. China— Foreign relations—21st century. 2. China—Foreign economic relations. 3. National security— China. 4. Monetary policy—China. 5. Renminbi. I. Shao, Binhong, editor of compilation.  JZ1734.A5C55 2013  327.51—dc23

2013016518

This publication has been typeset in the multilingual “Brill” typeface. With over 5,100 characters covering Latin, IPA, Greek, and Cyrillic, this typeface is especially suitable for use in the humanities. For more information, please see www.brill.com/brill-typeface. ISSN 2213-8439 ISBN 978-90-04-25583-8 (hardback) ISBN 978-90-04-25584-5 (e-book) Copyright 2013 by Koninklijke Brill NV, Leiden, The Netherlands. Koninklijke Brill NV incorporates the imprints Brill, Global Oriental, Hotei Publishing, IDC Publishers and Martinus Nijhoff Publishers. All rights reserved. No part of this publication may be reproduced, translated, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without prior written permission from the publisher. Authorization to photocopy items for internal or personal use is granted by Koninklijke Brill NV provided that the appropriate fees are paid directly to The Copyright Clearance Center, 222 Rosewood Drive, Suite 910, Danvers, MA 01923, USA. Fees are subject to change. This book is printed on acid-free paper.

Contents Foreword ............................................................................................................

ix

Introduction ......................................................................................................

1

Part ONE

China and the World 1..Thoughts on the Grand Change of World Politics and . China’s International Strategy ................................................................ . Wang Jisi 2.. China and the World: Balance, Imbalance, and Rebalance .......... . Guo Shuqing

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3..The Rich, the Poor, and China: China’s Responsibilities in an . Era of Three Worlds .................................................................................. . Li Daokui

45

4.. Understanding the Changing Relations between China and . Its Neighbors ................................................................................................ . Zhang Yunling

55

5..The China Model and World Order ..................................................... . Su Changhe

69

6..TPP: A Major Challenge to China in the Process of Its Rise ......... . Li Xiangyang

87

7..The Rise of China and the Adjustment of the International . Order—A Case Study of China’s Participation in the . Multilateral Trading System .................................................................... 105 . Song Hong

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Global Economy .

8. Global Economic Recovery: An Uphill Battle? ................................ Huang Haizhou, Li Zhiyong, and Wang Hui

127

. .

9.. Structural Changes of Global Economy and New Challenges of Emerging Economy ............................................................................. 155 Zhu Min Part THREE

Chinese National Security 10.. Chinese National Security: Its Missions, Sequences, and . Major Characteristics ............................................................................... . Wang Yizhou

181

11.. Japan’s Search for a National Identity and Its Historical . Reflections ................................................................................................... . Li Wei

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Part FOUR

RMB as an international currency 12.. Overcome the Fear of RMB Appreciation ......................................... . Yu Yongding

217

13.. RMB’s Internationalization under the System of Limited . Exchange Rate and Capital Account Control ................................... 237 . Zhang Bin and Xu Qiyuan 14.. How Can RMB Become an International Currency? Enhancing . the Status and the Role of SDRs in the International Monetary . System: Prospects for the Renminbi Joining the SDR Basket ..... 255 . Qiao Yide, Xu Mingqi, Li Rui, Ge Jiafei, and Shi Qing



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Part FIVE

Roundtable Forum 15.. China and the United States in the Next Decade ........................... 281 . Zhang Weiying, He Huaihong, Huang Haizhou, . Yuan Yaxiang and Wang Jisi Bibliography ...................................................................................................... Appendix  . Contributor List ........................................................................................... . Journal Information ................................................................................... Index ....................................................................................................................

313 325 333 335

foreword

China in the World During a Period of Change: How A Closer Examination of Chinese Elites Views Is Increasingly Essential to Understanding Both The last several years have been particularly eventful ones for China, especially regarding its relationship with the rest of the world. As the country’s meteoric rise has continued, tensions within Asia mounted, and doubts about America’s ability to continue to lead the current international order accrued, China’s leaders have found themselves in relatively uncharted terrain. For the first time in China’s modern history the country is on the threshold of becoming a major great power, one that has the ability to more actively shape the world in a way that is more consistent with emerging Chinese interests and identities. This prospect, while not yet fully realized, has generated a series of questions within China over how the world is changing, and what type of global economic and political actor the country should become. To begin with, many are asking how sustainable is the current status quo within international politics? Beyond this fundamental issue one finds evidence of a wide-ranging set of questions. For example, what is China’s rightful place on the world stage, and what can and should Beijing do to achieve such a goal?  Will the world remain unipolar as signs of American decline appear to be mounting, or is US dominance so pronounced that even a prolonged American economic downturn is unlikely to disrupt the country’s hegemonic status? How narrow, or broad, are Chinese interests within the international arena, and how much needs to change to insure that these are being protected and enhanced? What role do multilateral institutions now play in world politics, and how might they need to be transformed in order to meet emergent economic and security challenges? To what degree is it possible for China to maintain harmonious relations with its major Asian neighbors, and where does the blame lie for the current uptick in tensions over territorial issues along China’s borders? Did the 2008–2009 global financial crisis signal an end to an economic era? Has the international economy truly recovered from the downturn, and how unequally distributed will its long-term impact be? To what extent should China be changing aspects of its approach to foreign economic relations

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in light of emergent post-2008 economic realities? Is China’s currency, the RMB, poised to become an international currency, and what would such a development mean for the global economy and China’s own?  The manner in which China’s new leaders answer these questions will have wide-ranging implications for the country. They will also have a profound impact on the rest of the world. Indeed, the central questions of our time for students of international politics and economics hinges upon what Beijing intends to do with the new power and influence that appears to be at its disposal, and how China’s rise may reshape the contemporary international order. Uncovering the correct understanding of such concerns requires observers to look inside the Chinese foreign policy, national security, and foreign economic policy apparatus, to consider what the elites who operate within, and around, such institutions think about these issues. The views of such elites are all the more important as access to Chinese leaders is still limited, and their statements are almost always crouched in diplomatic language and political protocols, not to mention the tendency to present a unified stance to the outside world on how they view China’s relationship to the rest of the international political and economic system. As a result, it is all too easy to assume that a monolithic worldview has already taken root within China. However, beneath the surface of such public pronouncements resides an expanding universe of elite Chinese discussions about all of these pressing issues. Moreover, within such commentary and analysis can be found a wealth of opinions and analysis that quickly give lie to the conventional wisdom that those in China are converging around a singular perspective on how China, and the world, are both changing. On the contrary, Chinese elites are reaching a wide-variety of conclusions about these momentous issues, and proposing quite contrasting policy prescriptions for how China’s leaders should then most effectively deal with them. Unfortunately, however, most of these discussions remain relatively inaccessible to all but the most seasoned China-watchers, as they are written primarily in Chinese, and are published in journals that while enjoying wide readership in China are generally unknown outside its borders. This volume, the first of its kind, should go a long ways toward rectifying such a situation. In its pages are gathered a collection of translations of influential essays, talks, and papers, the vast majority of which have previously only been available in Chinese, which represent some of the



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most significant, and contrasting, assessments that Chinese foreign policy, national security, and foreign economic relations experts have forwarded in recent years. Such work, to date, has escaped the survey of outside analysts writing about China’s rise, and its implications for the international political and economic system. The book then is comprised of an unprecedented collection of translations of the most recent writings of China’s leading analysts of the global economy and international political system. While sweeping in scope, and as close to providing a real time snapshot of what is being said by Chinese elites about China’s emerging global role, a few minor limitations of the book should also be noted. First, the majority of these essays was published within China since 2011, and so reflects the most recent trends in Chinese thinking about the international economic and political system, and China’s place within it. This being said, the collection does include a few pieces that appeared earlier, but are given a place in this volume due to their seminal importance within Chinese discussions about the issues they raise. Second, in light of the enormous volume of work being published in China on these issues, a single volume, even a rather long one such as this, cannot hope to be entirely comprehensive. While pains were taken to utilize the most objective criteria for determining what would be included in the publication, the book is not necessarily entirely representative of all the main views being expressed by elites within China today. Third, the volume has rather more material on broad issues within foreign relations and the international political economy than it does on national security, bilateral relations with the U.S., and the Asian security dynamic. Finally, as the chapters are direct translations of Chinese works some of them do not follow the conventions and practices that readers might expect to see in academic work published outside of China. Future editions within this series will work to address these issues, yet, despite such limited shortcomings, this volume should prove to be an invaluable resource for any interested in developing a richer, deeper understanding of how elites within China are making sense of their country’s rise on the world stage. Experienced China-watchers will benefit from having such a plethora of views under a single cover. Those with a broader interest in international politics and economics, and an awareness of the increasingly prominent role which China is playing in shaping both arenas, will, for the first time, be privy to the remarkable discussions that are unfolding within China today regarding these pressing issues. The

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volume, then, is intended to shed insight into how China’s most important analysts of the foreign relations and the international economy view China in the world. Allen Carlson Associate Professor Government Department Cornell University Ithaca, NY

Introduction It has been over 30 years since new China opened its doors to the outside world and started to reform its economic and political systems. This policy of reform and opening-up brought about dramatic changes that China displays everywhere. China is now tightly integrated into the world with a rapidly growing economy, a series of shifts in its ideologies, and a multifaceted and more adaptive cultural value system as well as many great social and political transformations. There are no signs that this great change will end soon. China, at this moment, is in the era of transition; we even venture to say that it is on the eve of an important transformation. The new leaders of China face the major issue of how to adjust its economic structure and reform its political system. It is still difficult to predict the specific content of their plans and the depth and breadth of the reform, but there is one aspect of which we are certain: some institutional changes have to take place and people cannot wait any longer. The next 5 to 10 years are crucial for China. For the last 30 years, globalization has been very important to China in this historical transformation, and it will remain important through the changes that China will witness in the next few years. For the past 30 years, China left its doors open to the world to promote its internal reforms. One of the important results of this is that China tightly integrated with and became inseparable from the outside world, especially in an economic sense. But the world’s influences will play a different role this time. In the next several years, perhaps what China needs most is to seek and establish a new identity for itself in the world with the help of its comprehensive internal reform. While improving and promoting its image and its soft power in the world, China would also like to bear its share of responsibilities for the world and even make greater contributions to the human race. With this intention the editors of this book want to use this moment to review our experiences in recent past to understand what is happening at present and look to the future. But we are not willing and not able to do this in isolation. We hope to engage and collaborate with scholars in other parts of the globe, especially scholars in the English-speaking world, to explore the relationship of China with the other parts of the world, to discuss various issues, and to explore opportunities in other countries and regions that globalization creates.

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This volume is the first one of the series entitled China in the World: A Survey of Chinese Perspectives on International Politics and Economics. With the publishing of this volume in 2013, our plan is to publish one volume every year focused on topics of world economy, international politics, and other global issues. The first volume is a collection of recently published important articles of the best and the most influential scholars in China today that include thought-provoking findings and views in their selected fields. We as editors hope that this collection of various perspectives will promote ideological exchange and academic research among scholars in China and other parts of the globe, and help our readers all over the world to understand who and what are the most influential and widely read in China’s economic and political studies today. We have taken the following five steps to select the articles for this book. The first step was to scan our database of 40 top-rated journals and important studies written in English and in Chinese globally, and to search for articles and reports published since 2009 by Chinese scholars of international studies, and then prepare a detailed index of these items. We got over 1,000 articles from this step. The second step was to collect articles published since 2009 by about 80 first-rate and influential scholars in China. We have a little over 2,400 articles by this group. The third step was to study this database and contact the 38 most influential scholars, based on the citation and reprint rate of their articles, and to ask them to recommend their best articles published in recent years. The fourth step was to invite top scholars of world economics, international studies, and political studies to join us in order to ask their recommendations and explanations for the best authors and the best articles. The fifth and final step was meetings between editor-in-chief and our editorial team to discuss and debate the merits of each article and their relative importance. The editor-in-chief made the final selection after careful consideration. There were two main criteria we applied for the selection of articles in this book. First was the power of their insight as well as the strength of scholarship of the authors. Most authors chosen here are indeed top Chinese scholars and thinkers in their selected fields, and we also gave special considerations to those who are the most influential and famous in recent years. Many of them hold important academic, political, or government positions. Some are famed scholars. Their positions will add to their influence, but the most important consideration for us was their insight and their academic strength. Second, we considered the political, academic, and social influences of these articles, especially their influence over policy makers in China.



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Nearly all articles selected in this book have been published in periodicals in China that are dedicated to international studies. It is true that most writers had Chinese readers, not readers in the English-speaking world, in their minds when they wrote these articles, but the issues that they wrote about discuss how China faces the world as a member of the global community. Over the years, Chinese scholars of international studies rarely wrote and published articles just for the pursuit of their interest in pure theory and knowledge. On the contrary, in most cases, they wanted to explore the vast global environment in which the Chinese economy and society grow. They wanted to provide intellectual support to Chinese foreign policies, as well as to give accurate, comprehensive, and rational guidance to the general public on economic and social issues that China faces in the world. Most Chinese scholars, including Chinese political leaders, tend to have a strong desire to take care of their own business before fulfilling their global responsibilities. But since today’s China is a part of the world and what China does will greatly influence the world around it, the relationship between China and the world must be studied carefully and examined closely. This pragmatic approach of Chinese-speaking scholars of international studies to some global issues with writing styles and languages that are quite different from that of English-speaking scholars, plus the difficulty in translation, may not make this book a smooth read for an English-speaking audience. I believe these difficulties can be overcome gradually; what is important, is effort has to be made for mutual understanding between authors and readers. While most of our selections are academic articles, we have a few in our book that are not strictly academic papers in order to give readers a comprehensive picture of China’s academic world and some of its most vigorous academics with their focus on real problems, and to ensure that the selected articles do not lose their unique insight, predictability, and influence; for example, we have some articles with sharp comments as well as a speech that tries to explore the equilibrium between the Chinese and the global economy from a very unique point of view. We also have in our book an in-depth discussion of the most important relationship in the world, the relationship between the United States and China, by several brilliant Chinese scholars from some important but different fields of studies. With the exception of articles by Guo Shuqing, Su Changhe, and Yu Yongding, all articles selected for this book have been published after 2011. We chose these three articles published earlier for the first book of this series to give readers some historical perspectives. The rationales

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for their selection are either that the issues discussed in these articles are still important in China today, the great influence they have on academic discussions and government policies due to their pioneer studies and unique approach, or the importance and long-term relevance of their theoretical models. For future books in this series, our editors will adhere strictly to our general rule of only selecting articles published in the previous two years. There are five parts in this book. The first part is about the relationship between China and the world. It includes how China sees the world and the great changes that have happened in recent years: Chinese foreign policies and strategies, Chinese way of thinking and its cultural traditions, and their possible influence over international orders and Chinese foreign policies. The second part includes discussions on some global issues with an emphasis on world economy, especially emerging economies. The third part includes some independent studies of regions and countries. The fourth part touches a special topic: Chinese RMB as an international currency. The fifth part is a roundtable forum in which authors explore possible changes between China and the United States and the effects on their relationship. Obviously, this book is very “Chinese,” but China is always a part of the world with two major connecting points: economy and politics. The aforementioned selection process was to ensure the selection of the best articles for this first book in the series. Although we provide a summary of each article as well as the authors’ biographies, we want to briefly share the rationale behind the selection of each article. In Part One “China and the World,” the article of Prof. Wang Jisi from Beijing University “Thoughts on the Grand Change of World Politics and China’s International Strategy” represents the typical view on the characteristics and trends of world political changes by a mainstream scholar with influences on policy makers. He explains his understanding of China’s international standing today and in the foreseeable future, and the article expresses his thoughts on Chinese foreign strategies. He thinks China’s standing is far from “the second in the world,” and he prefers the term “the most powerful developing country.” China’s growth experience may not become a “Chinese model,” a level of universal significance. He believes that China still needs to be modest and prudent in its strategic thinking. Even though some Chinese scholars disputed this idea, his view represents the Chinese academic and political mainstream way of thinking, and his argument for China’s international standing and strategy is based upon his thorough analysis of the global political situation today.



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Guo Shuqing has a unique approach to and explanation of the dynamic relationship between China and the global economy in his article “China and the World: Balance, Imbalance, and Rebalance.” This article had some important influence in the economic policy making process of Chinese government. A high-ranking official in finances for the past many years and in his current position as Chairman of the China Securities Regulatory Commission, Guo Shuqing has been one of the important participants and policy makers for China’s economic reforms. This paper was his speech at Oxford University in 2009, in which he examined the global economic situation after the financial crisis. He pointed it out that the new equilibrium model of global economy was the imbalance between East and West, and especially the imbalance between the United States and China. This model would continue in the foreseeable future. In other words, imbalance would be a part of equilibrium and it would last for a long time. In the short term, he thought that the developed world should increase their exports while China should further stimulate its domestic demand and expand its foreign investments. In addition, China should reform the dual structures between its urban and rural areas and improve its financial system as well as push forward legal and political reforms. After the Chinese Communist 18th Congress, the new Chinese leadership expressed demand for further reforms in these areas with an emphasis on reform of the dual structures between its urban and rural areas. This shows that this article is still relevant and has an important influence in the policy-making process of Chinese government. Prof. Li Daokui of Tsinghua University graduated with a Ph.D in Economics from Harvard University. In his article “The Rich, the Poor, and China: China’s Responsibilities in an Era of Three Worlds,” he believes that the world entered into a new era that consists of three groups of countries: rich countries, poor countries, and China. He uses the literal meaning of the first Chinese word of China which means “middle” and “connecting two ends” to drive his point that China’s role and position will be different from those of emerging market countries, developing countries, and rich countries. In fact, China is the connecting point of poor and rich countries, and its function is to be a bridge connecting the two groups. Readers may reach some new conclusions when they try to understand China’s international responsibilities with this view in their mind. In his article “Understanding the Changing Relations between China and Its Neighbors,” Zhang Yunling deals with an issue of general concerns in political and academic worlds both inside and outside China: How to look at and judge the relationship between China and its neighbors. Zhang

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Yunling, a well-known Chinese scholar in Asian studies and the director of International Studies at the Chinese Academy of Social Sciences, thinks that the overall situation around China has not changed much, but China’s ability to build a favorable environment for its development greatly increased due to its rising power. In the foreseeable future, the most important strategic goal for China in handling the relationship with its neighbors is to actively promote a stable, peaceful, cooperative, and growth-oriented environment so China will not become a “lonely power.” Su Changhe’s article titled “The China Model and World Order” was published in 2009, and in it he tried to explore a unique “China experience” or “China model” that has existed for the last six decades. He thought that the concept of “cooperation,” which came from Chinese cultural traditions, was the core of the model, and it can be seen in the political progress and social orders of China. This “spirit of cooperation” embedded in Chinese social systems is quite different from “checks and balances” of Western social systems. It reflects the Chinese concept of domestic and world orders, and it can be utilized as an ethical and political resource to deal with problems occurred in international organizations. The author pointed out that many Western scholars think that politicians often use the concepts of “cooperation” and “harmony” only as strategic tools to seek more power and control instead of being the ultimate goals. Maybe these concepts are indeed the ultimate goals of Chinese politicians in that as a part of their value system, the concept of “peace” has deep roots that can be traced back through a thousand years of Chinese cultural traditions. Li Xiangyang, as the president of International Institute of Strategic Studies and an expert on political and economic relationships in AsiaPacific region, touches on a hot spot in international studies in China and his view represents the majority in his article “TPP: A Major Challenge to China in the Process of Its Rise.” He thinks Trans-Pacific Partnership (TPP) is an important component of the “return to Asia-Pacific” strategy of the United States. Besides its political and economical motives, containing China’s rise remains one of TPP’s undeniable objectives. For China, its exclusion from TPP not only means that it will be under the impact of “excludability effects” but it also means that the progress on regional economic integration in East Asia that China worked so hard for the past decade is likely to be reversed. China became the world’s largest exporter in 2009. One year later, China replaced Japan in terms of gross domestic product (GDP) and became the world’s second largest economy, only behind the United States. In his



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article “The Rise of China and the Adjustment of the International Order,” Song Hong explores the impact of these achievements of China on the global economic order and the global governance structure. He does not think the rise of China will disrupt or even significantly change the current multilateral trading system. He believes that China will play a leading role jointly with other core members in the multilateral trading system. Part Two of this book is about the global economy. The author of the article “Global Economic Recovery: An Uphill Battle?” is Huang Haizhou, the chief strategist of China International Capital Corporation, the most powerful investment management company in China. He and his team’s analyses on the recovery and future growth of global economy are quite well known to Chinese investors. Not sharing the optimistic views of many other observers, he pointed out that the road to recovery for the global economy after the financial crisis would be bumpy and tortuous. His research and analysis influenced some new policies of the Chinese government. To name a few of the major obstacles on the path of global economic recovery: policy stimulus will become less effective, heavy debt levels and lack of economic drivers in developed countries, and energy constrains the already hard-to-achieve rebalance of the global economy. Possible solutions are through structural changes in the global economy to achieve a new equilibrium in global economy. Next in our selection is Zhu Min’s article “Structural Changes of Global Economy and New Challenges of Emerging Economy.” One of the most significant features of global economic recovery after the financial crisis is the varied pace of recovery between developed economies and emerging economies. The decelerated growth of developed economies positioned emerging economies, for the first time, as the dominant force in global economic growth. Zhu Min not only is the highest-ranking official in the IFM who is from and represents China but he is also a very prolific scholar. In this article, he pointed out that although emerging economies are currently growing at a good pace, they need to fundamentally readjust their structure for sustainable growth, which will not happen automatically. Only through profound structural reforms in its growth models, policies, lifestyles, and other areas can emerging economies meet imminent as well as mid-to-long term challenges ahead. The Chinese government takes his ideas seriously in making their economic policies. Part Three of this book is about countries and regions with discussions focused on Chinese national security and its relationship with Japan. Because of an early cutoff date for our article selection, two articles selected in this book have not touched the topic of Sino-Japan relationship

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after the recent incident of Diaoyu Island, but they explored, in depth, the issue of Chinese national security and its relationship with Japan. Prof. Wang Yizhou, Peking University, is a leading scholar in international studies. In his article “Chinese National Security: Its Missions, Sequences, and Major Characteristics,” he discussed the five major tasks that China faces in its national security as an emerging power: responding to strategic frictions among major nations, handling the Taiwan issue and domestic separatism, resolving various sovereignty disputes involving China property, protecting growing Chinese interests overseas, and assuming appropriate responsibilities for world peace and security. To meet these challenges, China not only needs military involvement, it also has to establish new concepts and institutional arrangements as well as balance the two important areas of international and national interests. Ms. Li Wei is the head of the Japan Institute at the Chinese Academy of Social Sciences. In her article, “Japan’s Search for a National Identity and Its Historical Reflections,” she reviews Japan’s academic achievements and issues between China and Japan over the years. She points out that Japan’s national philosophy and American postwar policies toward East Asia have respectively served as the domestic and external factors preventing Japan from reflecting fully on its historical wrongdoings. Japan’s unfulfilled historical reflections leave uncertainty for East Asian security; thus, it is difficult for East Asian nations to accept Japan’s quest for “normal statehood.” Part Four discusses RMB as an international currency. The first article in this section, “Overcome the Fear of RMB Appreciation,” was authored by Yu Yongding and published in 2003. Mr. Yu is a highly respected economist in the Chinese academic field as well as among Chinese policy makers. He has been a long-term advisor to Chinese government on macroeconomic policies. This article explained in great detail how to increase the flexibility of exchange rate and overcome the fear of RMB appreciation. It also clarified the relationship between the flexibility of RMB exchange rate and the strategic transition for China to move into a more balanced economic growth. He advocated for the market to play a greater role in the exchange rate of RMB. He believed this would help to gradually eliminate structural imbalances in the Chinese economy so it could maintain its sustainable growth. This was not a popular view among Chinese economists in 2003. When the Chinese central bank finally restarted its reform of exchange rate on July 21, 2005, Yu Yongding was a member of the central bank’s monetary committee, and we believe he played a positive role with his policy advocacy based on rational analyses. Today, China still has issues regarding RMB as an international currency and the exchange rate



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reforms. I believe to start this part with a review of Prof. Yu’s idea will have some special significance. The article “RMB’s Internationalization under the System of Limited Exchange Rate and Capital Account Control” is co-authored by Zhang Bin and Xu Qiyuan. The authors found in their studies that in recent years even the Chinese government made great efforts to push RMB into an international currency; since the market has not decided the exchange rate of RMB, China’s efforts have not been successful. China should first let the market decide its RMB exchange rate and then RMB will become an international currency. In an exchange rate mechanism that does not reflect basic demand and supply in the market place, loosening capital control will attract larger attacks of speculative capital and threaten stability of the domestic economy. Many financial crises in Latin American and SouthEast Asian countries in the past should be served as lessons for China. “Enhancing the Status and Role of SDRs in the International Monetary System: Prospects for the RMB Joining the SDR Basket” is penned by Qiao Yide, Secretary-General of the Shanghai Development Research Foundation, and some other scholars. Qiao and his team have quite a few research reports on the flaws of the current international monetary system and their solutions. He believes the ultimate goal of reforming the current international monetary system is “global management of global credit.” Since it is not feasible to establish a global central bank or create a new global currency at the current stage, the reform can be carried out through an evolutionary approach, focusing on promoting the establishment of a more balanced multiple currency reserve system and enhancing the role of SDRs through expanding SDR issuance and improving its function as an international currency. It is promising for RMB to be a freely usable currency and to be included in the SDR basket in the IMF’s 2015 review of SDR valuation. The fifth part is the round table forum that I organized as editor-inchief of International Economic Review, in the ancient Fenghuang city of Hunan in 2011. The relationship between the United States and China is among “the most important” relationships that China has with the rest of the world. For this forum, we invited the most influential economists, political philosophers, scientists, international economists, and experts on international relations in China today. We asked them to predict what would possibly happen in and between China and the United States in the next decade based on their studies of the current situations. Their discussions were spirited, inspirational, and forward-looking. They debated if some factors that made the United States powerful could in turn become

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problems that lead to its decline. Generally, they agreed that in the next decade the United States would not fall as some people expected. But, the international position that the United States enjoys at this moment would depend on, to a large degree, what China would do. They also discussed national interests and core value systems of China and the United States. This article enjoyed a warm response when it came out, and we hope it would catch the reader’s attention here as well. Finally, I would like to thank the Institute of World Economics and Politics at the Chinese Academy of Social Sciences as well as its Academic Committee, its Chairman, and its members. They appointed me as editorin-chief, and this has helped me to fulfill my long cherished wish to publish a series of books to promote exchanges with my international peers. I would like to express my gratitude to all the authors of articles in this book and the journals in which they were first published. I thank them for their permissions to reprint these articles in this book. I would also like to thank all the experts and advisors who have helped me with the article selection and special thanks go to my team members for their great amount of labor and attention to details. They are Li Junwei and Cui Xiumei, editors of International Economics Review, Zhao Yuanliang, editor of World Economics and Politics, and Wang Hui, editor of the Journal of World Economy. I also need to thank Wu Yixue, director editor of China Daily, Zhu Qiwen, journalist of China Daily, Xu Xiaohong, lecturer at the Department of Diplomacy, China Foreign Affairs University, Wang Tianyang, Zhang Hugo, a freelance translator based in Los Angles and Mark Hughes, the executive business editor of China Daily who helped to polish the English translation. I also want to thank Ms. Christine Grant, who copyedited the English translation. Finally, I would like to thank Ms. Xie Na who introduced me to many famous international publishing houses after learning of my intention so that I could have the opportunity to make contacts with them. Lastly, I would like to thank Brill Academic Publishers for publishing this book for us. For the past six months, I have learned a great deal in working with Ms. Qin Higley of Brill and Prof. Allen Carlson from Cornell University. Being the first volume of the series, this book is bound to have many flaws, and we welcome precious feedback from our readers so that we can improve in the future. Shao Binhong Executive Editor-in-Chief of International Economic Review Institute of World Economics and Politics Chinese Academy of Social Sciences Beijing

part one

china and the world

chapter one

Thoughts on the Grand Change of World Politics and China’s International Strategy Wang Jisi* Abstract: This paper includes three topics: The first is the characteristics and trend of the grand change of global politics; the second is the issue of China’s international position today and in the future; the third is a brief discussion on China’s grand strategic choice. After analyzing the evolution of world politics in the past three decades, the author summarized five basic characteristics of global political changes. During this time period, China has kept trying to change itself and as a result the whole world. The relationship between China and the world is undergoing accelerating historic changes that have propelled China to constantly rethink its international position or national identity. This paper summed up China’s international position from four aspects. Regarding Sino-US relations, the author believes that it is necessary to draw three lines to avoid misjudgment on this bilateral relationship. The United States and the whole Western world have indeed brought about clear strategic, political, and security challenges to China. But it is both unworkable and unwise for China to base its international strategy on “making the US an enemy.” As one of China’s strategies, Taoguangyanghui, yousuozuowei (to hide one’s capacity, bide one’s time, and seek achievements), is still of vital realistic significance and should be held firm and not be abandoned. Keywords: World politics, change, China, international position, international strategy

* Wang Jisi is Dean of the School of International Studies and Director for the Center for International and Strategic Studies at Peking University. His email address is wangjs@ pku.edu.cn. This paper is compiled on the basis of the author’s following articles: (1) Wang Jisi 王缉思, Tang Shiqi 唐士其, “Sanshinian lai shijie zhengzhi fazhan de jiben tezheng 三十年来世界政治发展的基本特征 [The Basic Characteristics of the Development of World Politics in the Past Three Decades],” International And Strategic Studies Report, 4 (2010) published by the Center for International & Strategic Studies of Peking University; (2) Wang Jisi 王缉思, “Zhonguo de guoji dingweiwenti yu ‘taoguangyanghui yousuozuowei’ de zhanlue sixiang 中国的国际定位问题与“韬光养晦、有所作为”的战略 思想 [China’s ‘International Position’ and the Strategic Thought of “keeping a low profile and make due contributions],” International Studies, 2 (2011); (3) Wang Jisi 王缉思, “Zhongguo da zhanlue qiusuo 中国大战略求索 [In Pursuit of China’s Grand Strategy],” Oriental Morning Post, Feb 28 to March 2, 2 (2011); The author here expresses thanks for Zhao Minghao 赵明昊, associate researcher with China Center for Contemporary World Studies, who offered a lot help on this paper. The Chinese version of this article was first published in Zhongguo guoji zhanlǜe pinglun 中国国际战略评论 [China International Strategy Review], 2011.

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A series of social and political turmoil in the Broader Middle East and North Africa at the beginning of 2011 ushered in the second decade of the 21st century in a surprising way. Regardless of their differences in nature and root cause, these events clearly highlighted the increasingly important role in domestic and international politics played by ethnic and religious groups, social organizations and even individuals (especially the young generation equipped with Internet communication tools) albeit nations remain the most important players in the international arena. Domestic politics and social stability will still be key factors that affect international security, and international interventions in domestic politics have intensified and taken on complicated forms. In this sense, internal politics in countries and regions around the world has in fact constituted a significant variable in assessing China’s international strategic environment, which must be taken into consideration when China deliberates and designs its future international strategy. China’s national strength and international influence has increased rapidly in recent years, and has drawn close attention from many countries in the world. They have increasingly incorporated the China factor in designing their development strategies and formulating foreign policies. Such a rapid increase in national strength and international prestige has also influenced the attitude that the Chinese people adopt to observe international affairs and the approach they take to deal with international relations. Therefore, how China defines its international role has become another key consideration when policymakers, think tanks, and scholars study and discuss China’s international strategy. For the above-mentioned reasons, this paper focuses on two topics: one is the nature and the trend of the world political changes; the other is the issue of China’s international role today and in the future. Finally, the paper will comment on China’s grand strategic choice. Ι. The Basic Characteristics of the Grand Change of World Politics The current changes in the Broader Middle East and North Africa are attributed to by some accidental factors as well as the broader context of world political changes since the end of the Cold War. With the acceleration of globalization and the spread of information technology, the political dynamics occurring in one country has exerted a growing impact on its immediate neighbors and remote corners. Therefore, compared with the regional features and national character, which are more familiar to



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the observers of international politics, the ramifications and the characteristics of the world political changes deserve a closer scrutiny. The development of world politics in the past three decades can be roughly divided into two phases. In the first phase, political liberalization and economic marketization are the basic trend of world political changes, on account of which US political scientist Francis Fukuyama enthusiastically declared that history, has ended.1 In the second half, liberalization and marketization face new challenges and suspicions. Those nations that have adopted a liberal democracy have to painfully explore the localization of democracy to improve and cement their basic institutions. Market fundamentalism was resisted and criticized to a certain degree and neo-liberalism, the ideological base for political democratization and economic marketization, was also frequently questioned. In the meantime, the rapid development of civil societies, the growing prominence of the non-traditional security challenges (i.e. environmental issues, energy and food security, and public health, etc.), the politicization of religious and ethnic issues, and the rise of extremism of various forms around the world, all have posed new challenges to governance capacities of the national governments and redefined world politics. A preliminary study of the dramatic changes of world politics in the past three decades helps to shed light on the following conclusions. First, the pursuit of freedom and democracy is universally recognized. The degree of democracy and freedom in a country has become one of the fundamental yardsticks of political legitimacy worldwide. Under any national condition or political condition, it is hard to defend dictatorship, family ruling, information blockade, and a lack of transparency in government work and abuse of human rights. Developed countries in the West have always enjoyed such a stable democracy that neither serious financial crises nor minor social unrest has fundamentally shaken their political systems. Few countries adopted a competitive multi-party system in the 1970s, but most countries had done so by the latter half of the 1990s. Today, even countries such as Burma and Iran that are deemed as dictatorships have nominally maintained multi-party politics or universal suffrage. From a long-term perspective, there is an irreversible trend of the transition of non-West countries toward democratic politics. But it is noteworthy 1 Francis Fukuyama’s essay “The End of History?” was published in the international affairs journal The National Interest in 1989 and his book The End of History and the Last Man was published in 1992. In the book, Fukuyama argues that the advent of Western liberal democracy may signal the end point of humanity’s sociocultural evolution and the final form of human government.

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that while a mature democracy is yet to emerge among Muslim countries, and the Central Asian countries are returning from imitating Western democracy to strongman politics, which is more familiar to them, Eastern and Central European countries, which have maintained the Western cultural tradition, are in a better position to adapt quickly to the multi-party democracy. It shows that, on the one hand, religious, cultural, and political traditions all play an important role in democratization; on the other hand, the timing and progress of democratization is not necessarily determined by the degree of economic development. Nevertheless, the latter is definitely related to the maturity of democratization. Second, democratization in different countries is in different stages of development and thus has various goals and features. The traditional democracy in developed countries displays some deficiencies and shortcomings. For example, the rights of minorities are undermined under “competitive majority voting,” as a result of which “consensus democracy” and “deliberative democracy” have come into being. Western countries have also carried out reforms in electoral systems, parliamentary system, power-sharing mechanism between the central government and local governments, and the strengthening of the oversight of government activities through public opinion. After the end of the Cold War, many non-Western countries have been able to explore their own development strategy in a relatively easy environment. Despite the fact that the US employed military means to “liberate” Iraq and Afghanistan to promote local “democratization” and “street politics” by force, and that “color revolution” in some countries occurred against the background of Western influences, democratization in nonWestern countries as a whole charts an inherent and independent course and reflects the political will of the general public. All the problems arising in the course of democratization, such as bribery, corruption, violence, and political discords, cannot belittle the value of democracy itself and the significance of their efforts of “trial and error” in the process of experimenting democracy. The process, form, and outcome of democratization may vary from country to country. Nevertheless, it has been generally acknowledged that democratization does not necessarily mean westernization. Third, apart from civil liberties and the democratic system, stability and order are the political goals that each and every country pursues. Historical experiences demonstrate that be it in developed or developing countries, a dynamic balance needs to be maintained between freedom and democracy on one side, and stability and order on the other side. Excessive freedom enjoyed by either individuals or minority groups can result in social divisions, value distortions, civil strife, social disorders, and



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even and violent confrontations. The combination of liberalism, materialism, and consumerism has not only elicited a serious scarcity of resources and the deterioration of the ecological environment, it also led to a general decline of public morality and a flagrant expansion of individual greed. These problems are even more severe in those newly democratized nonWestern countries. The political system and rule of law in these illiberal democracies are not mature enough. But under the temptation of Western lifestyles and the influence of Western values, the growing expectations of the general public have far exceeded the pace of their economic growth and social progress. In some countries in the Broader Middle East and North Africa, some people have expressed their complaints in such a violent way that their actions are posing a threat to social stability and political order. Meanwhile, the efforts to maintain social order have often resulted in the abuse of power, which infringes upon individual freedom and undermines the rights of the underprivileged. Countries around the world have been seeking the solutions to keeping dynamic balance between the guarantee of individual freedom and the maintenance of social order. Nevertheless, be it the traditional socialism, or the traditional liberalist ideas, or even the return to a political system that integrates politics with religion such as Iran since the Islamic Revolution in 1979, all have failed to provide a right answer to the accomplishment of social justice. Fourth, with regard to the relations between state and society and between government and market, liberal capitalism guided by neo-liberalism and its thoughts has undergone a process of “negation of negation,” but a really competitive revolutionary force has yet to come. It was deemed as a universal value between the 1980s and the 1990s to reduce state intervention in society and government intervention in the market, but the blind worship of neo-liberalist thoughts and institutions was widely questioned and denied in the past decade. However, it remains a problem that demands a solution in practice on how to strike a proper balance between state intervention and market freedom. The wealth gap is drastically widening in every country around the world. Environmental deterioration, ecological imbalance, financial instability, and social cleavages all call for government efforts to check greed, safeguard justice and maintain social harmony. But if the government works for vested interests and is not transparent in decision-making, the more power it has, the more serious social imbalance will become. That is why the “Third Road” can hardly find any substantial spiritual connotation and policy support. At the beginning of the 20th century, revolutionary ideas represented by Leninism had sparked remarkable social movements that aimed to end

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the rule of capitalism and establish communism. Yet, such movements are rare at the beginning of the 21st century. Sporadic violent activities that ostensibly aim to overthrow “the evil hegemony of American capitalism” have been labeled as “terrorism” and despised by the international community. The so-called “anti-globalization movement” can only be promoted by disorderly crowds lacking thoughts for guidance, an economic base, and organizational force. Global governance, aiming to address a series of global challenges, is hindered by quiet inter-governmental cooperation, competition and bargaining, and thereby unable to generate any revolutionary force. Fifth, the new generation of social movements and rapid growth of civil societies are going beyond the understanding of the traditional political logic and the border of national states and become key factors and driving forces in correcting global social and economic imbalance. On the global scale, such issues as peace, environmental protection, human rights et al. have gained unprecedented political weight and become an inseparable part of every country’s policy-making. Meanwhile, such new social identities as ethnic identity, cultural identity, religious identity, idea identity, and interest identity deriving from concerns over ecological and environment deterioration and public health have also gained tremendous weight. Concepts such as individual freedom, individual rights, diversity of thoughts and culture have taken root in every corner of the globe. From a global perspective, the opposite of liberalization and diversification is no longer naked ideological dictatorship in the name of state, but is reflected in the form of soft and non-national social identities. Sovereign states will still be the major players in world politics and enjoy the loyalty of their citizens. By carefully studying the world political and intellectual history, it is not difficult to find that the world composed of sovereign states is not permanent in mankind’s history. For instance, in some countries in the Broader Middle East and North Africa, a large number of people identify more with their clans, tribes, ethnic and religious groups than with their traditional sovereign states. That is why Sudan has been divided into two countries and Syria is now faced with the danger of disintegration. The past 30 years are just a “fleeting moment” in the history of mankind. But within this period, world history has realized an upward spiral. Compared with the Cold War period, world politics has become more colorful and, in a sense, more uncertain. The world is confronted with new problems and challenges. The earthquake that happened in Japan on March 11, 2011 is case in point. In the face of natural disasters such as tsunamis and earthquakes, and non-traditional security challenges such as



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environmental degradation, energy and food shortage, public health, and the rise of extremisms of various forms, how can states deliver good governance? How can the international community achieve co-governance? And how can humans respond to the common challenges? The history of the past over 30 years shows that although the Soviet model has become a historical endeavor, the West nowadays cannot provide a proven model and a ready-made answer to help achieve national unification, economic development and social progress, either. Emerging markets such as China, India, Brazil, South Africa, and Russia have inspired new hopes, but everything they have achieved is still on the nascent, experimenting stage and their universal significance is yet to be tested by history. In this sense, the old history has indeed ended and a new world history is just unfolding. II. What Kind of a Country Is China? In the 30 or more years since reform and opening-up, China has always been “changing itself and influencing the world.” The relationship between China and the world has undergone accelerating historic changes that propel China to constantly rethink its “international role” and “national identity.” The precondition for us to consider China’s international strategy in the next decade is: against the broad background of world politics, how can we clearly understand China’s role in international affairs, and how can we define the question “what kind of a country is China?” In terms of national strength, a question still open to debate is that after its GDP surpassed Japan’s, has China become the strongest nation in Asia, and therefore is second only to the US? I think, compared with Japan, China not only boasts an immense population, vast territory, and large economic size, but China also possesses a larger scale national defense system and nuclear weapons. It is fair to say that in the AsiaPacific region, China overtook Japan in political influence, geopolitical advantage as well as geo-economic advantage. Therefore, it should be a generally accepted view that China is the most powerful Asian country. However, other factors must also be taken into account. Although China’s comprehensive “hard power” slightly exceeds that of Japan, Japan’s status as a developed country and its alliance with the US significantly compensate for its geopolitical disadvantage. Moreover, in terms of people’s living conditions and breeding, culture and education, and scientific and technological levels, Japan does far better than China, and its cultural power in

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Asia is no less than China’s. It is equally important not to ignore the fact that Japan has strong national cohesion, solid political institutions, longterm social stability, and a good ecological environment. Furthermore, the economic recession over the past two decades and frequent changes of the government have not led to political turbulence. Nor has the initial panic precipitated by the unprecedented earthquake and its subsequent tsunami developed into hysteria, thanks to Japan’s ability to cope with natural disasters in an efficient and timely manner. In brief, Japan’s slow but stable economic growth, solid political institution despite the frequent administration transitions, plus its steady social progress, efficient disaster-addressing mechanism, advanced science and technologies, and expanding cultural influence in East Asia put Japan in an equal, if not a more advantageous, position in its competition with China, a fast-growing economic power with increasing regional and international weight. All that said, it will therefore be a big mistake to overlook Japan’s strength in China’s foreign relations. Europe is another entity that also cannot be belittled. China’s economic strength has surpassed that of any single European power. However, the EU as a whole has an economy as large as the US, and the euro has already become an international currency that can compete with the dollar, but the internationalization of the renminbi still has a long way to go. The gap between China’s comprehensive power and global political influence, and that of the EU is still large. So, in terms of GDP, the Chinese economy has become the world’s second largest and is developing with sound momentum. But it is totally unrealistic to conclude that China’s power has overtaken Japan and the EU and become the world’s No. 2 economy, and will catch up with the US in one or two decades. China is far from becoming the world’s No. 2, particularly given its underdeveloped cultural power and weak voice in international arena. A proper evaluation of China’s position among global powers is that China is the strongest developing country. But the booming economies such as India, Brazil and Russia all have their own strengths and weaknesses. Second, China is located in the center of traditional geopolitically defined Asia (with the exception of West Asia, and Siberia, which is often referred to as Russia’s Far East). As its economic interdependence with neighboring countries increases, China becomes the geo-economic center of the Asia-Pacific region, and plays a leading role bigger than that of the US and Japan in the regional economic development. China has participated in almost all regional economic organizations in East Asia and is also a core member of the Shanghai Cooperation Organization. In spite of



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the economic prominence, the geopolitical situation China faces is quite different. As a firm believer and a staunch supporter of non-alignment movement, China does not form any formal political or military alliance with any neighboring country, which puts China in a more disadvantageous geopolitical position in the face of the US alliance network in East Asia. What’s even more problematic, China has many hard-to-solve territorial disputes over land and water with Japan, India, and Vietnam and some other neighboring countries. The US-led “hub-and-spoke alliance network” is playing a pivotal role in East Asia security, and China is a concern in such military arrangements. Under such circumstances, China cannot speak on behalf of East Asia on the international political arena as Germany, France, or Brazil does for Europe or South America. In other words, from geographical perspective, China is identified as an Asian country, which gains increasing recognition as an economic powerhouse. However, few countries in Asia are willing to share China’s political values and recognize it as a political “leader” or “spokesman” for Asia. Although some Chinese people are enthusiastic about talking of “Oriental culture” or “Asian civilization,” the Chinese civilization, more specifically the Han civilization, is only part of diverse Asian cultures, along with the Indian civilization, the Persian civilization, the Japanese civilization and others. The Chinese civilization differs from other Asian cultures as much as it does from the Western civilization. Hence, China is one of Asia’s centers, but not the “leader” above all other major nations. There is indeed a rapid global expansion of China’s interests and influence, but in no way is China in a position to rank itself as an equivalent to the US, the only global superpower, in the coming few decades. Furthermore, in terms of the nature of political systems, China is one of the few socialist countries in the world with unique political-economic institutions, a political value system, and mainstream ideology. China faces many uncertainties in its development path because it is undergoing reforms of profound and long-term significance. China has yet to realize complete territorial unification and is threatened by ethnic separatism. Despite the rapid economic growth, China faces many such challenges as social disharmony, the deterioration of ecological environment, daunting tasks of social governance, and sluggish transformation of economic development model. While its national coffers are strong enough to fund grand projects with concentrated effort, China’s per capita income remains low and its wealth gap has been widening. Despite the firmness of the political system, China is short of capability for institutional innovation, and its social cohesion is yet to be enhanced. Although the mainstream socialist

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ideology remains unchallenged and the socialist nature of its public education remains dominant, social trends of thoughts and public opinions have become increasingly diversified, and the government is increasingly concerned about and has taken precautious measures against the political and thought penetration by overseas hostile forces. Out of domestic and international concerns, China has adopted an attitude starkly different from that of Western countries towards the multi-party system, democratic transformation, and national division in many developing countries. The above-mentioned national conditions and policies indicate that the institutional and ideological differences between China on one side and developed countries and even some developing countries on the other side remains colossal and shows no signs of narrowing in the foreseeable future. China is thus regarded by Western developed countries as “different” in the international community. China’s “international role” is defined as the role China plays and the responsibility China assumes in world affairs. What role China plays is determined by the above-mentioned three factors: China’s overall power, complicated geopolitical and geo-economic position, and unique political system. For instance, China’s power position as the largest developing country determines that China is not a dominant force in the current international political and economic order. In consideration of its own interests and the limited strength compared with the western industrialized countries, China has accepted international rules advocated by Western countries on non-proliferation of nuclear weapons, counterterrorism, trade and investment liberalization, protection of intellectual property rights, and climate change while joining in the dollar-led international currency system. Meanwhile, the increase of national strength gains China an increasingly significant weight to its opinion in international organizations as well as more international responsibilities on foreign aid and peacekeeping. China’s geopolitical position determines that its input of political and economic resources and influence in neighboring countries is much bigger than in other areas around the world. The nature of China’s political system determines that it is under tremendous political pressure from the Western value system that advocates democracy, freedom and human rights. China resists such pressures and insists on the principle of non-interference in other countries’ domestic affairs in the international community. Another problem related to international position is whether China’s unique development path can become a model for other countries to learn from and copy. Although debates among domestic and international



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academics about the “China Model,” also known as the “Beijing Consensus,” are very hot, the Chinese authorities have no intention of promoting its development path and experience in countries around the world. Premier Wen Jiabao even directly told a news conference during the annual sessions of the National People’s Congress and the Chinese People’s Political Consultative Conference in 2011 that there was not a “China Model.” I have always believed that China’s development and experience cannot yet be summarized into a model because China Model under exploration is still in the making and far from success. There are indeed some countries in the world that want to learn from China. But no one is able to copy the set of China’s systems. Of course, the above-mentioned roles interact with each other and cannot be clearly separated. In short, China’s international role can be summed up into the following four points: (1) China is a developing country with the strongest national power and still falls far behind the US, the EU, and Japan on the maturity of economic development, science and technology, education, and overall cultural power; (2) China is an Asian power that sees a global expansion of its interests and influence, but it still has not assumed a dominant role in Asia; (3) China is a major socialist country with a unique political structure and value system, but it is undergoing profound reforms and has yet to realize complete territorial unification and is threatened by ethnic separatism; (4) China is a beneficiary, participant, and reformer of the current international political and economic order while being limited by Western-led international rules. These views are some basic conclusions based on reality, not wishes. Because of the above four conclusions, I believe there will be little change in China’s international position, situation and “identity” in the next decade. Ⅲ. What Type of International Strategy China Needs When thinking and analyzing China’s international strategy, the characteristics of world politics and China’s international role are undoubtedly among the decisive factors that we need to judge first. Between the 1950s and the 1970s, world politics was dominated by the struggle for hegemony between the US and the Soviet Union, and the third world also witnessed the height of national liberation movements, also known as “decolonization” in the West. China’s international position at that time can be summed up as a big Oriental country featuring the Soviet model, a “rebel” against the international order and an isolated poor country. So it was

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natural that China’s international strategy was then called “Chairman Mao’s revolutionary diplomatic line” guided by “proletarian internationalism.” Today, world politics and China’s international role utterly different from what they used to be several decades ago. Any country’s international strategy must answer at least the following three questions: (1) What is the country’s core interest? (2) What is the major external threat the country faces? (3) How can the country properly and effectively deal with the external threat? During the Mao era, China’s core interest in international relations, a concept not available at that time, was the maintenance of the stability of the revolutionary political power; the major external threat was the US or the Soviet Union, the US and the Soviet Union together for a period, and China’s primary means to deal with the threat, in addition to military struggle, were diplomatic efforts to establish a united international front against the US or the Soviet Union, or both. Today, the Chinese authorities’ definition and understanding of the country’s core interest is clear, consistent, and based on a prevailing consensus. Policy measures and strategic choice closely related to core interest decide that this concept does not permit ill-conceived alteration or hasty interpretation. In December 2012, China’s State Councilor Dai Bingguo made clear in his signed article Sticking to the Path of Peaceful Development that China’s core interests in international affairs are: (1) China’s form of government and political system and stability; (2) China’s sovereignty, territorial integrity, and national unity; (3) the basic guarantee for sustainable economic and social development of China. And these interests do not brook violation.2 Dai Bingguo’s article has not linked any region or problem beyond China’s border to the concept of core interests. In the past months, some Chinese commentators have declared the South China Sea and North Korea as China’s core interests. Such unauthorized statements, to a certain extent, have deepened foreign suspicion about China and exerted a lasting negative effect. After a country’s core interests are clearly defined, identifying the major external threat will then become the most important challenge in its international strategy. In world history, the external threat for a country was often another country. Yet, in today’s era of globalization, profound

2 Dai Bingguo 戴秉国: “Jianchi Zou Heping Fazhan Daolu” 坚持走和平发展道路, [We Must Stick to the Path of Peaceful Development], Renmin Ribao人民日报 [People’s Daily], 2010.12.13.



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changes have occurred in world politics and international relations. A noteworthy international political phenomenon in the post-Cold War era is that, be it developed countries such as the UK, France, Germany, Italy, and Japan, or booming economies such as India, Brazil, Mexico, Russia, South Africa, and Turkey, no single country has identified any other country as their biggest external threat or their enemy in their official statements. Although every country still faces external threats today, few have identified any specific country as their definite enemy. After the 9/11 attacks, the US has regarded international terrorism and proliferation of weapons of mass destruction as the biggest threat to national security and once called Iran, Iraq, and North Korea “the axis of evil.” However, the Obama administration has made a different judgment and statement from that of the Bush administration on external threats. The National Security Strategy that the US released in May 2010 pointed out: “Instead of a hostile expansionist empire, we now face a diverse array of challenges, from a loose network of violent extremists to states that flout international norms or face internal collapse. In addition to facing enemies on traditional battlefields, the United States must now be prepared for asymmetric threats, such as those that target our reliance on space and cyberspace.”3 It is fairly certain that although American strategists generally recognize that the rise of China will pose a challenge or even a threat to the US, today’s US government and mainstream political forces have not defined China as an enemy country. Where does the major external threat China faces come from? Many Chinese observers will answer in unequivocal terms: “Of course it comes from the United States” or, more broadly speaking, from the West. Some people also think that the US is China’s enemy country and argues that this is beyond doubt. Otherwise one is considered either “unable to distinguish ourselves from the enemy” or as just “a traitor.” This is a very serious issue that should be clarified by drawing three clear lines of demarcation. The first line of demarcation is to distinguish two important and utterly different questions in terms of strategic and political scope. Is a country objectively threatened by one or several enemy countries? Does a country “needs” an “enemy country” to consolidate its internal order? The remark by Mencius that “a state without an enemy or external peril is absolutely

3 The White House, “The National Security Strategy of the United States,” May 2010. http://www.whitehouse.gov/sites/default/files/rss_viewer/national_security_strategy.pdf.

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doomed” answers the second question. US political scientist Samuel Huntington also admitted that the US “needs” a strong enemy to solidify its national and cultural identity. He said, “The ideal enemy for America would be ideologically hostile, racially and culturally different and militarily strong enough to pose a credible threat to American security.”4 It is true at all times and in all countries that some people will always try to achieve domestic political goals by highlighting the threat of a strong external enemy and make it a strategy or a policy. Some Chinese observers often cite Mao Zedong, who said, “It is the number one question for revolution to distinguish whom our friends are from whom our enemies are.”5 The logic goes like this: The first priority for China’s international strategy is to distinguish friends from enemies; now that the US is viewed as an enemy, its allies, such as Japan, will naturally be viewed as enemy countries or hostile forces, and the anti-American forces around the world should be viewed as China’s friends or allies. For thinkers like Huntington, to define China as an enemy country is taken for granted, and there is no need to examine whether China’s strategic intentions are benign or hostile, or whether Chinese foreign policy objectives are restrained or expansive. Similarly, for thinkers who insist that “China needs an enemy country” or the principal problem for China’s international strategy is to draw a clear line between friends and enemies, the intention of the Obama administration’s strategy for dealing with China and the significant changes in world politics are irrelevant to their assessment. But the question whether China and the US have become enemies to each other or will ultimately become enemy countries demands a clear-headed strategic analysis from a much broader and more realistic perspective. The second demarcation line is the fact that some Americans view China as an enemy country; which does not necessarily mean that the US policymakers and mainstream political forces define China as an enemy country and formulate the US long-term strategy on the basis of reciprocal animosity. Equally important, neither is the view to regard the United States as an enemy country held by some radical fringe in Chinese society able

4 Samuel P. Huntington, Who Are We? The Challenges to America’s National Identity (New York: Simon and Schuster, 2004), 262. 5 Mao Zedong 毛泽东 Mao Tse-tung: Zhongguo shehui ge jieji de fenxi《中国社会各阶 级的分析》[Analysis of the Classes in Chinese Society], Mao Zedong xuanji diyijuan《毛 泽东选集》第1卷 [Selected Works of Mao Tse-tung Vol. I] Renmin chubanshe 人民出版 社 People Press, 1969 年 9 月第 1 版 Sep. 1969 the first edition, 第 3 页Page 3.



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to represent the official line of Chinese policymakers and the mainstream political forces. In the joint statement released during his visit to the US in January 2011, Chinese President Hu Jintao confirmed the long-term goal of “building a Sino-US cooperative partnership,” which is entirely different from the argument that defines “China and the US as enemy countries to each other.” The third line is that the posture that the United States constitutes a security threat, political challenge, and economic competition to China does not necessarily mean that the US is China’s enemy country, let alone the largest external threat to China. The US, Japan, and other western countries hold a negative view on China’s political values. Western politicians sympathize with and even support Dalai Lama and the separatists from the Xinjiang Uygur Autonomous Region. The US continues to sell arms to Taiwan. The US-led military alliances bring heavy pressure on China’s security. The US business community and Congress wage “currency war” and “trade war” against China. All these challenges posed to China by the United States certainly call for consistent efforts to cope with. But this does not necessarily justify the “enemy country” argument. China needs to address these challenges with concerted efforts; that was for sure. Moreover, when we concentrate all our efforts on tackling our domestic challenges, such as boosting economic development, transforming the economic growth models, improving people’s living standards, advancing education, science and technology, we will come to realize that China’s biggest challenge or even threat does not necessarily come from the United States. As long as we keep our own house in order, the pressure from the outside can be greatly alleviated, and we will have a fresh understanding of China’s external strategic environment. For a long period during the Cold War when class struggle was taken as a top priority in national policy, China faced a severe and even hostile external environment. The major threat to China’s national security came from the United States (1949–1972) and the former Soviet Union (1969–1989). In the era of reform and opening up, China’s definition of external threat differs enormously from that of the Cold War era. At the present time and in the foreseeable future China views accelerating the transformation of economic growth model as the pivotal mission. In this context, the challenges China faces are multifaceted and multifold, which, in some aspects, are more complicated and more severe than ever before. Here are a few examples: in economic field, the fluctuation of international financial situation, economic recessions in some countries and consequent shrinkage in imports and the rise of economic nationalism

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and trade protectionism; in the traditional security field, the escalation of territorial land disputes and territorial water disputes, the danger of military conflicts at sea, the problem of the development and proliferation of nuclear weapons in neighboring countries, and international terrorism; in the non-traditional security field, energy shortages, soaring resource prices, climate change, safety for overseas Chinese citizens and companies, public health, and food safety. The challenges engendered by the current turmoil in the Middle East to China are also multifaceted. Meanwhile, interaction between domestic and international conditions has become much closer and deeper than 20 years ago. Domestic and international challenges are interwoven and interchanged, which are increasingly difficult to prevent and to deal with. It is still a long way to go before China translates its growing national strength into policy measures to effectively safeguard its core interests. So, it will be more sensible to define the major external threat to China’s core interests as the multifaceted challenges from many a specific issue than as one or two specific countries. The US and the whole western world have indeed posed clear strategic, political, and security challenges to China, but it is neither practical nor sensible to define and formulate China’s international strategy on the basis of “making the US the target enemy.” The reason is simple: If China views its largest trade partner, also the world’s largest economy and military power as its enemy, it is impossible to stick to the path of peaceful development. In terms of feasibility, there is hardly any country in the world that would like to join China in establishing a long-term anti-American coalition. For the benefits of both countries and the world at large, China and the US should make joint efforts to build a cooperative partnership based on mutual respect and mutual benefit to advance the common and shared interests of the two sides, make better use of the opportunities and more effectively cope with the challenges of the 21st century. Another related key problem is whether China will stick to the strategic thought—“keep a low profile and make due contributions,” which is intentionally or unintentionally mistranslated as “hide one’s capacity, bide one’s time and seek achievements.” If the answer is yes, how can its development keep pace with the times? This far-sighted strategic thought, to keep a low profile and make due contributions, proposed by Deng Xiaoping in the late 1980s, means to guard against western political conspiracies, avoid confrontation with the west in implementing China’s foreign policy, and promote the stability of domestic and international situations. The two decades that followed the 1980s witnessed the dramatic rise of China and the relative decline of the West. In this historical con-



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text, some people in China suggested that such a non-confrontational approach is outdated and should be replaced by a more assertive attitude, i.e., taking every possible measure to defend China’s rights and interests, even at the risk of breaking up relations with other countries, and showing no fear of confrontation with the outside world, particularly with the west. But a thought-provoking question is: why do people feel that China has faced mounting international pressure in recent years, particularly in 2010 when the US and Japan were plagued by difficulties at home and abroad, and the EU was troubled by sluggish growth and decreasing cohesion. To answer this question, we need to examine the root cause of the drastic transformation in world politics and understand the domestic and international factors at play. It should be noted that the political, economic, and military alliance systems formed during the Cold War among the western industrialized countries still remain intact, and the West as a whole enjoys a marked advantage over China in the current international political and economic order. Their advantages in science and technology, culture, education, and innovation capacity as well relatively stable domestic politics and rule of law are the foundation upon which they can maintain their international superiority in the foreseeable future. The rise of some emerging markets has, to a certain extent, undermined the dominance of the western industrialized economies in the international system and partly alleviated the pressure of the West on China. But it has also brought about new and unpredictable factors which further complicate China’s international strategic choice. It is fairly certain that the dramatic changes in international relations, such as the rise of the emerging markets and the relative decline of the West, do not necessarily or naturally bring about the improvement of China’s international strategic environment. Under these circumstances, the international challenges China faces at present and in the foreseeable future are increasing instead of decreasing. In this context, it is still of utmost realistic significance to stick to, not to abandon, the strategic thought, “to keep a low profile and make due contributions.” Nevertheless, sticking to this strategic thought does not mean clinging to established practices. The essence of this strategic thought cannot be inherited if it is not replenished and adjusted in line with the development and change of domestic and international situations in the past two decades. This strategic thought was originally meant to deal with the USled Western world when relations with Western countries were the top priority for China’s diplomatic work. But today, China’s diplomacy faces a broader horizon, a more complex situation, more cooperative partners,

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and more competitors. If “to keep a low profile and make due contributions” is made a guideline for China to deal with its relations with other emerging markets or global challenges such as financial crisis and climate change, it is obviously inappropriate and pointless. In order to stick to the essence of this strategic thought while avoiding the negative connotation as a result of mistranslation or misinterpretation, I would like to make two suggestions. First, shy away from using the phrase as a declaratory policy statement to avoid its negative connotation due to mistranslation and misreading and replace it with “being modest and prudent.” The phrase of “being modest and prudent” conveys no derogatory sense at home and abroad. It is more explicit in its meaning and properly reflects the essence of the Chinese culture. The Chinese government, Chinese enterprises, and Chinese citizens should all display the spirit of “being modest and prudent” in their exchanges with developed and developing countries, in their international economic and other activities as well as in their overseas travel, work and study. The second suggestion is to understand and express China’s long-term strategic goals and development direction more accurately. Dai Bingguo once remarked: “The objective of China’s development boils down to one sentence: To build a harmonious society at home and help build a harmonious world abroad. This means China will first of all be responsible to its 1.3 billion people and also responsible to people around the world and world peace and development so that the fruits of China’s development can benefit both its own people and the international community.” He also said: “Some say China wants to replace the US and dominate the world. That is simply a myth.”6 But sometimes we can also hear another kind of thought and statement about the objective of China’s development, the so-called “catch-up” idea, a typical example of which is the slogan of “surpassing England and overtaking the United States” popular during the “great leap forward” era in the 1950s. Now, some people pick up this cliché again and propose regarding the surpassing of the US economy and military as the long-term objective of China’s development. Some people believe that whatever the Chinese people want to build or do, they should set their sights high, and make it the world’s highest, largest, strongest, most expensive, and most elegant

6  Dai Bingguo 戴秉国: “Jianchi Zou Heping Fazhan Daolu” 坚持走和平发展道路, [We Must Stick to the Path of Peaceful Development], Renmin Ribao 人民日报 [People’s Daily], 2010.12.13.



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and realize “the Chinese dream” the same as “the American dream.” They are willingly drinking the poisoned chalice of illusion and oblivious to the fact that this is simply a myth. Not to mention how the outside world will look at us if the second objective and thought were publicized with great fanfare, given the realities of China’s large population, limited natural resources, deteriorating ecological environment, largely unfavorable geographic conditions, and relatively weak economic base, all would make it a myth to rebuild an American-style superpower. The realistic strategic objective for the country should not be to overtake the US but to surpass China itself. This is to take into account domestic and international situations, based on the requirement of the Scientific Outlook on Development, accelerate transformation of the model of economic growth while putting emphasis on quality but not size, on people’s welfare but not projects for political scores, on social justice and harmony but not escalating social unrest, and on real efficiency but not various world ranks. Internationally, China’s objective should evolve from saying “what it does not want” to saying “what it wants,” from pursuing the accumulation of power to making a contribution to the world through thought innovation and institutional innovation, from seeking overseas market shares and the expansion of demand for resources in the process of globalization to facilitating improvement of market rules and international institutions, and from promoting multi-polarization of the world of power politics to joining with countries around the world on developing the rule of law and justice in the international order and improving global governance. Only when China evolves from a major power with a large population, impressive economic power, and significant political influence to one with high levels of harmony, education, science and technology, and culture can the dream of rejuvenating the Chinese nation come true.

CHAPTER TWO

China and the World: Balance, Imbalance, and Rebalance Guo Shuqing* Abstract: The rapid growth of the Chinese economy has increased global supply and has created global demand tremendously, so there is not anymore shortage of capital. The new model for world economic equilibrium is the imbalance between East and West, or mainly the imbalance between the United States and China. This new model will remain in place for a long time. In the short term, we can see the possibility of following adjustments to the world economy: Growth of exports by developed countries, increasing domestic demand in China, and China’s expanding investment overseas. In the long term, the world economy will face great energy and environmental challenges. Looking at the future of the Chinese economy, one of our worries is whether or not China will follow in the footsteps of other emerging industrial countries and in turn experience a long period of stagnation after rapid economic growth. China needs to reform the dual structures between its urban and rural communities, improve its imperfect financial system, and continue its reforms in legal and political areas. Human capital is crucial to China’s economic growth in the future. Keywords: Chinese economy, world economic balance, imbalance, rebalance

This paper examines the current economic relationship between China and the rest of the world and investigates China’s influence on the new pattern of economic growth in a global context and if it is sustainable; the process could be described as a cycle from balance to imbalance and then rebalance. China’s growth impacts how and where other countries choose to manufacture goods as well as the relationship between nations in debt and nations that have a trade surplus. While China’s economic boom has its positive points, China still remains a poor county with colossal gaps in quality of living between its regions, and lacks an education system that promotes creativity and the drive to discover new methods. In order for China to keep up with its own economic progress, a look at what was and what is becomes important. * This article was originally a speech given at Saïd Business School, Oxford University on 29 May 2009. The Chinese version was published in Bijiao 比较 [Comparative Studies] 4 (2009). Guo Shuqing is Chairman of the China Securities Regulatory Commission and Executive Committee Vice Chairman of the IOSCO. His email address is [email protected].

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guo shuqing I. The Significance of China’s Economic Take-Off 1. Increasing Global Supply Dramatically

Under open economic conditions and in this time of globalization, economic takeoff of newly industrialized countries is usually accompanied by fast-growing productivity and providing many cheaper goods to the world market. Examples of such countries are the United Kingdom, the United States, Germany, and Japan. The increase of the supply of commodities and services has been fast. This is just like the United Kingdom in the first half of the nineteenth century. Production increased rapidly and the price of textiles decreased by 80 percent in 50 years. The recovery of Germany and Japan after World War II and the rise of the Asian Tigers (Hong Kong, Singapore, South Korea, and Taiwan) were similar. The increase in large amounts of supply led to better world living standards. In principle, China is no different from other new emerging economies. China’s contribution is the same. But, China is an extremely large country. That makes a significant difference. China has 1.3 billion people, which accounts for 20.7 percent of the world population. This large number is equivalent to the population of all developed countries such as the United States, European countries, Japan, Australia, and Russia all added together. With foreign direct investment and advanced technology, China’s production capacity expanded extremely fast; Higher Chinese productivity increased supply to a dramatic extent. It is estimated that 20 percent of commodities in the United States came directly or indirectly from China. In the European Union, the number may be less, but quite close to that figure. As for Russia and Eastern Europe, it is more or less the same. In China’s neighbouring countries, the figures are much higher. And in other developing countries of Latin America and Africa, there are more and more Chinese goods. All these countries benefited not only from cheap goods and good quality but also from better and cheaper services. In the past 20 years, the world inflation rate has been significantly lower than that of previous decades for example the 1970s and 1980s. China’s rise is one of the main reasons. We could see this in the United States and Europe. Not only is the rich countries’ inflation milder but China’s economic takeoff also helped to lower the consumer price index in developing countries as well.



china and the world: balance, imbalance, and rebalance 35 2. Creating Substantial World Demand

2.1 China’s Economic Rise China’s rise and subsequent economic opening-up and development led to more imports of capital goods, raw materials, and consumer goods. China is by now the largest buyer of iron ore and other nonferrous metals in the world. China is also one of the major buyers of cotton and soybean. China produced 580 million tons of steel in 2008. Half of the steel was used in housing construction. More than half of the world’s steel and cement are produced and used in China. Since the 1990s, it is apparent that the curves of fluctuation of China’s economic activities and major world commodities prices are basically the same. The Chinese demand increased the price of commodities. 2.2 Equipment and Technology China attached high importance to the expansion of production from the very beginning of its economic reform. It imported a large amount of equipment and technology from Europe, Japan, and the United States. In the 30 years since China’s opening-up and reform, developed countries benefited a lot from exporting technology and capital goods to China. In the time subsequent to China’s opening-up and reform, consumer goods such as daily commodities and electronic appliances played important roles in raising people’s living standards and driving industrial growth. They were also effective in opening people’s minds and changing the way of thinking of the Chinese. 3. Making Capital a Non-Scarce Resource 3.1 China Has the Economy with the Highest Savings Rate in the World The Chinese economy is vast in scale; savings at present are about 50 percent of GDP, more than 2 trillion US dollars. It is also the nation with the most recently increased savings surplus, with the annual increase amounting to 400 billion US dollars. And its accumulated foreign exchange reserves hit 2 trillion US dollars. Anything China can produce will become cheaper. Savings and capital finance are the same. China exports a great deal of products, but the most critical items are savings and cheaper capital. China’s domestic infrastructure construction is also the largest in scale in the world. Let’s take China’s urban underground construction as an example. More than 65 lines of subway are under construction. Beijing alone has thirteen lines of subway under construction simultaneously, which is unprecedented.

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Shanghai has ten lines and Guangzhou has eight lines of subway under construction. The rise of China meant that capital was not that scarce a resource. This is perhaps the most historically critical event in the past 10 years. A savings rate surplus and export of capital often accompanied the economic takeoff in newly industrialized nations, as the United Kingdom, United States, Japan, Germany and, most recently, by the four Asian Tigers proved in the past. Since the capital is not 100 percent used in domestic industries, it is exported to other countries. This savings surplus is equivalent to a trade surplus or current account surplus. Although China is a developing country, its savings rate is much higher than other countries. Since 1993, China’s savings rate has been around 40 percent for 16 years. For the other countries, the figure is around 20 to 30 percent. Actually, China is changing very fast, did especially in the past 10 years. About 20 years ago, when I was working for the State Planning Commission of China, one of the difficult problems was infrastructure financing that is financing the railways, power stations, and highways. Since then, financial conditions have changed greatly. Financing is no longer a problem. China issued 42.6 trillion of bank loans in 2009. From January to April of year 2009, 5.17 trillion yuan have been lent. Banks tend to be eager to lend to good projects for a better investment and financial resources are not scarce any longer. Being non-scarce, however, does not mean free. It should not be forgotten that China is still a poor country. There are massive disparities between regions. China still has a large population numbered at 30 to 40 million people below the poverty line. And it should also be remembered that a significant proportion of China’s savings are actually held by external investors, including Americans, the British as well as Hong Kong and Taiwan investors. II. A New Pattern of World Economic Balance 1. The New Pattern and the Old One In the world economy, there are always countries with trade surpluses and countries with deficits. As always, total surplus is equal to total deficit. In newly industrialized countries, because of improved productivity and accumulated capital, normally a savings surplus comes into being. The world economy was like this for several hundred years ever since the Industrial Revolution led by the United Kingdom.



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In the past, savings mainly came from developed countries such as the United Kingdom. Two hundred years ago, the United Kingdom was an emerging country as well as the most developed country. As a newly industrialized country, it exported more goods and services and thus created surpluses. At the same time, it exported capital and made investments around the world. In the 1950s and 1960s, savings surplus mainly came from industrial nations such as France, Germany, and Japan, at which time the United Kingdom and United States became debtor nations while Western Europe and Japan became creditor nations. Then, after the two oil crises that took place in the 1970s and the rise of the Four Asian Tigers, the pattern changed. Today, however, capital is coming from developing countries. Most of the developed countries are in deficit now. Japan, Norway, and Switzerland have some surplus. Germany has some surplus, but the European Union counted as a whole is in deficit. The United Kingdom was in deficit earlier. The United States experienced a current account deficit ever since the early 1970s, and its overall balance of payments became negative in the 1950s, even earlier than its current accounts. Currently, China is the largest savings surplus nation; Japan and Europe shrunk. The key point is that China is a major provider of capital. But it is not a developed country and it is not an advanced industrialized country either. In the past, people talked about imbalance, which referred to disparities among developed countries. Now, people worry more because that means the differential between the West and the East, mainly the United States and China. 2. Is This New Pattern Sustainable? A US Perspective The question is not in that the developed countries are borrowing money. This pattern has existed for more than half a century. The United States turned from a creditor country into a debtor country in the early 1960s, but that did not affect the economy. Its competitiveness is still the strongest. The creditor-debtor relationship is not a simple good-bad or advanced-backward relationship. For the world economy, money must be borrowed and used; this is normal. The abnormal part lies in that today developed countries borrow instead of providing capital to developing countries. In addition, the developed countries borrowed money and then went for consumption. The United States is a typical example. This deserves our discussion. The United States example has two sides. I think there is over-consumption in the United States and resources are wasted too much. The United States consumes around 23 percent of

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the world’s energy according to 2007 figures. Recently the figure might be lower, but still more than the energy consumed by 51 percent of the world’s population in other countries added together. Of course, the 23 percent of world energy consumption was equivalent to the United States’ GDP percentage in the world economy, even though it has only 4.5 percent of the world’s population. We say the US economy has an irrational side of over-consumption, for example the phenomenon of suburbanization. More people, travelling by automobile, live in suburbs and causes high-energy consumption. However, it also has a rational side. The US expenditure on science, research, education, culture, travel, and Medicare are the highest in the world. This spending is beneficial for enhancing human capital. In the current statistics accounting system, this expenditure is regarded as consumption. Borrowing money to go to university should be encouraged because it could be paid back. It is not irrational. Consumption like this would increase human capital and intellectual capital, which leads to better “soft power.” If such developing countries as China also follow suit, this pattern would not be sustainable for all of the world’s oil would have to be sent to China. From the perspective of markets, politics, and international relations, this is not obtainable. Therefore the sustainable part lies in the fact that enhanced human capital and intellectual capital can bring strong innovation capabilities. Even though the United States has turned into a debtor country for more than half a century, what is most important for economic and social development are intangible assets instead of tangible assets.1 The developing countries are not in an advantageous position because they are backward in knowledge, technology, information, and creativeness. The United States still boasts the strongest competitiveness in the world. There are 551 US firms, nearly 28 percent of the total, among the Forbes Global 2000, covering almost every sector of the global economy and invariably they are the leaders in their respective industries. The European and Japanese companies are dwindling.

1  Dutz, et al. (2012) estimates that during 2000–2008, annual business spending on intangible assets or knowledge-based capital in Brazil averaged about 4 percent of gross domestic product. This is significantly lower than comparable rates for the United States, Japan and the United Kingdom, which hover around 11 percent. Hulten & Hao (2012) finds that intangibles have played a significant role in China’s recent growth. But China’s intangible Investment was only 7.06% of GDP in 2006, compared with 10.35% in the U.S.



china and the world: balance, imbalance, and rebalance 39 3. From the Perspectives of Savings Surplus Countries, Is This Pattern Sustainable?

Let’s look at this issue from the perspective of savings surplus countries such as China. It is difficult for the savings surplus of China to disappear. Why? High savings surpluses are related mainly by three factors: Development Stage Newly industrialized countries tend to have more savings. These countries normally need capital-intensive industries such as chemical, automobile, and cement. The input is very large. Manufacturing comes with rapid depreciation. Housing is built very fast and the average floor space for living increases. Services are undeveloped and supply is limited. International Divisions Low, value-added industries and manufacturing industries moved from developed countries to underdeveloped countries. This process in China has not been completed. To some extent, developed countries make China’s savings higher. Multi-national companies earned very high profits in developing countries, and they use this money to reinvest again in many places. Cultural Reasons Two kinds of countries in the world have high savings rates and long saving periods. Apart from oil-producing countries, there are two groups: (1) Countries or regions heavily influenced by Chinese culture, such as China, Japan, Singapore, Hong Kong, and Taiwan; (2) The Germanspeaking circle such as Germany, Switzerland, Denmark, Austria, and The Netherlands. It takes a long time for low, value-added production and manufacturing dominated countries with savings surpluses such as China to change their tradition and course of development. China is large in size. When low, value-added production in the coastal area’s export driven industries decreased, they were shifted to the inland Western and Central China. This can be recently seen happening in the country’s structural adjustment, therefore, nationwide industry upgrading and the sifting out of low value-added industries will not happen soon. Even if China no longer had a savings surplus and trade surplus, the pattern would last for a long period because other developing countries could replace China’s position as major savings surplus countries. It could

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be a group of countries, for example, India, Mexico, Vietnam, or even Indonesia. III. Possible Adjustments of the World Economy in the Short Term 1. The Current Signs of Imbalance May Change and It Actually Has Already Happened The current financial crisis and credit crunch scared banks from lending and individuals from borrowing. The developed countries led by the United States will have to change their consumption patterns through greatly reducing consumption and imports, resulting in fewer exports from the developing countries such as China. It is forecast that in 2009 both the imports and exports in world trade will decrease by nearly 20 percent. Although the current crisis played a large role in the decline of trade, the consumption and the imports of developed countries will not return to the previous level even when the economy recovers. The ever-rising oil price will also force the developed countries to consume less energy. De-suburbanization will become a trend and more people will choose to live in condominiums in cities instead of villas in suburbs. The developed countries, including the United States, reached a consensus on reducing energy consumption. The US policy makers especially now want to cut oil imports, and the Obama administration launched a plan to develop green energy. 2. The Developed Countries Should Increase Their Exports Presently, there are many export controls, especially on high-tech and defense-sensitive goods. By doing so, developed countries actually economically shackle themselves. This is both unreasonable and unfair. The developed countries to welcome more inbound investment should eliminate trade barriers, protection, and investment limits. Take China as an example. Currently, the overall attitude toward China’s outbound direct investment is not friendly. For example, many western countries, including the United Kingdom, labeled China’s investment in Africa as new colonialism. Many Chinese companies have already taken steps to try to invest overseas, but they are faced with great difficulties such as local government objections, trade union, and labor law



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issues. They need more support and assistance from the external world in the developing stage. 3. China Needs to Expand Its Domestic Demand So far, China’s consumption has maintained the fastest growth rate in the world. Since a lot of service industries are not counted as an independent market business, China’s consumption capabilities have been underestimated for a long time. Every time we carry out a nationwide economic survey in China, GDP figure would be revised due to the underreported contribution of the service industry. In 2009, the situation will be similar and the GDP may be slightly higher after revision. In fact, China’s consumption is higher than both external analysis and domestic statistics suggest. For example, consumer retail sales in China have increased by 13 percent annually over the previous five years. In the past five years, housing floor space per capita has increased by around one square meter annually. In the past 10 years or so, automobile purchases have increased by more than 30 percent and in 2009 China has become the largest automobile market in the world. In addition, China is the largest exporter of textile and garments, creating several dozens of billions in US dollars of exports every year, which, in fact account for only 20 percent of the total output. The other 80 percent are consumed in China domestically. However, China still needs to stimulate its inadequate domestic consumption. The major challenges China faces in this regard are: (1) The dualistic structure of the rural and urban areas and the wide disparity between them in terms of purchasing power lead to a fact that in China the rural population’s per capita consumption only accounts for one fourth or one fifth of that by the urban population; (2) Service consumption lags far behind commodity consumption. The public service level is much lower than the economic development level. For example, 80 percent of the total healthcare expenses have been spent in cities but the 80 percent covers only 20 percent of the entire population; (3) Urbanization has been taking place at a much slower pace compared with the industrialization process. China needs to increase its overseas investment in areas such as energy and raw materials, which will boost world supplies and be vital for the balance of the world economy. Every year China registers more than 400 billion US dollars in surpluses so China has the capital to invest. By the end of 2008, China’s net overseas assets amounted to 1.5 trillion US dollars, and total overseas assets reached 2.92 trillion US

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dollars. Among the 2.92 trillion US dollars, only 6 percent or 169.4 billion US dollars were outbound direct investments, and 67 percent were foreign exchange reserves, amounting to 2 trillion US dollars, 9 percent were portfolio investments and 18 percent were other investments in the forms of trade finance, bank loans etc. China can absolutely expand its outbound direct investments, which will bring benefits not only to China itself, but also to the United States, the United Kingdom, and many other countries. From China’s perspective, the foreign exchange reserves ensure liquidity, but the return on the investment is low and the proportion is too high. However, China is still lacking in relevant management skills, experience, and talent. It has a long way to go before China can fully improve the situation. Chinese people favor monetary assets and prefer good liquidity, which will discourage some of them from directly investing overseas. In 2008, China directly invested 58 billion US dollars overseas, which was double in 2007. The direct investment overseas can translate into the input of capital, production capabilities and demand, which is welcomed by foreign governments, agencies, companies, and civil societies. IV. Challenges Facing the World Economy in the Long Term As the global economy develops, some challenges emerge and the whole world faces them. Every country has its own responsibilities and no single country or any two countries, such as the G2, can solve those problems without concerted efforts. 1. The Energy Issue Shows Developing Countries Cannot Repeat Previous Growth Structure The outlook for the energy issue is not that optimistic. If developing countries such as China were to follow the US example in energy consumption, the entire world’s oil would have to be sent to China, and it still may not be enough. The only way lying ahead is to save energy and reduce waste. The new energy technologies cannot generate enough power to meet the demands of long-term economic development. The world is still very much dependent on fossil fuels. According to the chief economist of the International Energy Agency, by the end of 2030 the proportion of new energy, such as hydropower, wind power, nuclear power, and solar power in electricity/power generation will not have increased by much due to impediments such as cost and food safety worries. The whole world will still mainly rely on oil, natural gas, and coal for electricity.



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The implementation of new energy is still very difficult and costly. Whether it is to save energy or to develop new energy, both need closer cooperation within the international community, especially among major economic powers such as the United States, the United Kingdom, China, Japan, and the European Union. 2. The Environmental Protection Issue Needs Coordination and Cooperation among Countries China surpassed the United States as the largest greenhouse gas emitter. Because of the large population, lifestyle, cost, and technology issues, it will be difficult for China to solve the greenhouse gas emissions problem in the short term. At the same time, China produces a lot of export goods consumed by other countries, which also contributes to a colossal portion of its greenhouse gas emissions. But China is very active in the area of environmental protection. The United States has become more positive, too. On December 5, 2007, the Senate Environment and Public Works (EPW) Committee passed America’s Climate Security Act (ACSA) by a vote of 11 to 8. ACSA was the first legislation containing an economy-wide carbon cap to be passed by a House or Senate committee. This achievement laid new groundwork for future congressional action on mandatory emissions reductions. The bill covered the power and industrial sectors, production of transportation fuels, and residential and commercial use of natural gas and heating oil. The emission targets for covered sectors were 15 percent below 2005 levels by 2020 and 70 percent below 2005 levels by 2050. The Global Warming Pollution Reduction Act has a target of 80 percent below 1990 levels by 2050. The bill calls for a 2 percent reduction in emissions from 2010 to 2020 to reach 1990 emissions levels by 2020. The interim targets are approximately 27 percent of 1990 levels by 2030 and 54 percent of 1990 levels by 2040. If the United States is able to successfully implement these acts, it will be a great blessing to all human beings and will set a good example for other developed countries. It is necessary for both the developed countries and the developing ones to cooperate in this area. 3. The Issue of the International Financial System and Currency Countries shall coordinate and cooperate in ensuring effective regulation and adequate security of the international financial system. The foreign exchange rate fluctuations of some major countries negatively affect many developing countries. How to lessen those negative effects? How to

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establish an effective central bank mechanism, making the central banks as the last resort of funding and bailout? At present, neither the IMF nor the World Bank is able to play this role. Therefore, the central bank of every country has to undertake the role to contain the outbreak or spreading of a financial crisis. V. Outlook for China’s Economy 1. The Biggest Concern about China’s Economy The largest concern about China’s economy is whether or not China will follow other industrialized countries, such as Japan, and go into a long stagnation period after 20, 30, or even 40 years of fast growth. The possibility exists. 2. Where Does the Concern Come From? (1) China needs to reform its dualistic structure of rural and urban areas. (2) China needs to improve its financial system. The financial industry in China is still underdeveloped. Its proportion of the total GDP and its employment proportion of the total employment are still very low compared with developed countries such as the United Kingdom. The access to financial services for many Chinese small- and medium-sized enterprises or newly founded companies is still very limited. The financial industry in China has not yet invented good ways or opened effective channels to stimulate and support entrepreneurship. (3) China needs to carry out its legal and political reform. 3. The Development of Human Capital Will Be Vital for China’s Future Economic Development Currently, there’s a big gap between China and other developed countries in terms of education, training, and environment for grooming talent. The present education system is not conducive to encouraging innovation, which will hinder the progress of China’s economy to a high level and sustainable development in the future.

CHAPTER THREE

The Rich, the Poor, and China: China’s Responsibilities in an Era of Three Worlds Li Daokui* Abstract: The world economy will likely suffer from the ongoing financial and public finance crises for a long time. I argue that we will be in an era of three worlds consisting of rich countries, poor countries, and China. China’s role will be especially important in the coming adjustment process that will follow the financial crises. China needs to resolve these critical economic issues in the coming decade: Reduce the trade surplus, support the stability of the international financial system, and promote key reforms in the international economic system. Those will be of great benefit not only to China but it will also benefit the world. Keywords: Global governance, rise of emerging powers, China’s responsibility

From my point of view, the world has seen revolutionary changes in the international economic and financial system following China’s entry into the World Trade Organization (WTO). The changes in the last 10 years are more significant than the changes after World War II. Over the past 10 years, terrorism has become a hot topic that deserves the attention of political leaders of all nations. At the same time, we experienced the most severe financial crisis of the past 70 years. Up to now, the poison of this crisis has not entirely affected the world economy and people are still witnessing the changes resulting from the crisis. I. An Era of Three Worlds: The Rich, the Poor, and China Our Era Consists of Three Worlds: The rich countries, the poor countries, and China. For the rich countries the financial crisis was initially a crisis of the balance sheet in the private sector, which was repaired by national credit within three months. However, the world today faces intense * The Chinese version of this article was first published in Guoji jingji pinglun 国际经 济评论 [International Economic Review], 4 (2011), 10–16. Li Daokui is Professor of Finance and Director of the Center for China and the World Economy at Tsinghua University as well as the vice president of the China Society of World Economy. His email address is [email protected].

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crisis and conflict, which developed countries can reflect very severe public finance problems, and seeing their national credit decrease except for some German-speaking countries, such as Germany and Nordic countries. I do not think these public financial problems can be resolved in a year or two, because, unlike China, 60 percent of developed countries’ public finance expenditure is entitlements, which are citizens’ various welfare programs guaranteed by law. This kind of expenditure is rigid, and cannot be cut in the short term. How will this pattern evolve in the long term? Governments, taxpayers, and welfare recipients must rebuild new social contracts. This is difficult and requires extensive reform. Objectively speaking, the developed countries need profound reforms in the post-crisis era, which calls for dynamic political leaders like Ronald Reagan and Margaret Thatcher, in addition to leading scholars and new theories. But so far, I cannot see such political heroes or scholars proposing theories that offer profound, systematic social reforms, and the re-signing of social contracts in developed countries in the era of globalization. I firmly believe that in the next decade developed countries will experience a very difficult adjustment process. Second, are all the poor countries or the developing countries, especially the emerging nations, performing well? Not exactly. These countries are also facing profound problems in macroeconomic management. Take India and Brazil, for instance. These countries experienced rapid growth and look beautiful on the surface. However, major problems exist in their macro management, both Brazil and India have experienced twin deficits (fiscal and trade deficit) in the recent decade, while at the same time, China has maintained fiscal prudence with balanced budget and relatively high trade surplus. Table 3.1 and Table 3.2 below show the fiscal and trade balance of India and Brazil with China as a comparison: Table 3.1. Government Budget Balance of China, Brazil, and India (Percentage of GDP, negative means deficit) Year

China

Brazil

India

2004 2005 2006 2007 2008 2009 2010

–1.31% –1.23% –0.77% 0.58% –0.40% –2.29% –1.63%

–1.86% –3.59% –2.89% –1.87% –1.21% –3.47% –1.67%

–7.06% –6.36% –5.11% –4.00% –8.00% –10.00% –4.70%

Sources: China Statistics Yearbook; India official statistics, including India Public Finance Statistics 2009–2010; WDI database released by the World Bank; IMF databases.



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Table 3.2. Trade Balance of China, Brazil, and India (Percentage of GDP, negative number means deficit) Year

China

India

Brazil

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

2.41% 2.12% 2.57% 2.20% 2.55% 5.53% 7.70% 8.80% 7.72% 4.41% 3.03%

–0.92% –0.89% –1.00% –1.29% –1.75% –2.75% –3.04% –4.03% –5.43% –4.44% –5.65%

–1.76% –1.32% 1.51% 2.91% 3.88% 3.61% 2.90% 1.52% 0.19% –0.06% 0.92%

Sources: China Statistics Yearbook; WDI database by the World Bank; data released by foreign media for the statistics on India and Brazil.

I think a relatively cautious judgment is that in the next 5 to 10 years there will be a new round of financial crises in developing countries and emerging market countries. India and Brazil have had a trade deficit for a long time. India’s trade deficit has been rising over the past decade, reaching 5.65 percent of GDP in 2010. Brazil eliminated its trade deficit from 2002 to 2008, but the deficit returned in 2009. Although Brazil, under the leadership of President Lula, experienced a short-term budget surplus, it is now back in the position of having a budget deficit. India’s financial situation is also quite worrisome. Therefore, not all developing countries are experiencing smooth sailing. (See Table 3.1 and Table 3.2) In short, the new world financial situation is quite grim and very complex. The world economy probably will go through a painful and complex adjustment in the next 5 to 10 years. Under such circumstances, China’s position is particularly important. I argue that the world today formed a new pattern and divided into three groups of countries: the rich, the poor, and China. China’s role and status are different from both emerging market countries and developed countries. China is actually a bridge between rich countries and poor countries. From this perspective, we need a new understanding of China’s international obligations.

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li daokui II. The Responsibility of China

In the next decade, when the international economy continues to fluctuate, China will encounter three major issues to resolve: (1) reducing the trade surplus; (2) preserving the stability of the international financial system; (3) promoting the key reform of the international financial system. Successfully accomplishing these goals is in the best interests of China and the world. 1. Reducing the Trade Surplus The first issue that deserves attention is that China already contributed a great deal to the rebalancing of the global economy over the past two years, although this fact did not propagate well. As an example, take the area of global trade: Before the financial crisis in 2007, the trade surplus was as high as 300.7 billion US dollars, which comprised 8.8 percent of total GDP.1 After more than two years of expanding domestic demand and stimulating economic growth, the trade surplus dropped to 183.1 billion US dollars in 2010, comprising 3.03 percent of GDP. The trade surplus decreased further, dropping from 180 billion US dollars in 2010 to around 150 billion US dollars in 2011. If China continues adjusting the domestic industrial structures and reducing the trade surplus, the share of trade surplus in GDP will drop to below 1 percent. When that happens, China should confidently proclaim to the world that it has made enormous contributions to rebalancing the global economy. Actually, if the US and Europe devote their efforts to reducing the trade deficit to around 2 or 3 percent, the world economy will become balanced and many international problems, such as global imbalance, maybe solved. However, those in China have not adequately articulated the contributions China has made to the world. This is due to the lack of confidence Chinese scholars and officials have in challenging those widely held and uninformed views. China needs to strengthen its academic research capacity in order to enhance the effectiveness of such communication. Besides, it is also important for China to strengthen the frequency and the depth of academic communication with foreign scholars. 1 He Liping made systematic analysis on this topic before, see He Liping 贺力平, “Renminbi huilv yu jinnianlai zhongguo jingchangzhanghu shuncha 人民币汇率与近年 来中国经常账户顺差 [Exchange of RMB and Current Account Surplus in Recent Years],” Journal of Financial Research, 3 (2008), 17–31.



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It is the international norm agreed by G20 summits held in 2010 that the current account balance over GDP should be no more than 4 percent. Indeed, the Chinese government agrees with this principle, but China needs also to specify its unique situation. For China’s economy, it is not appropriate to consider the ratio of current account balance to GDP; the better practice is to use the ratio of trade surplus to GDP. The current account balance consists of two parts. The first part is trade surplus and the second is returns on investments. The returns on investments are the claims to the accumulated financial securities that are held abroad. For example, China holds the returns on the 3 trillion US dollars in US exchange reserves. The two parts of current account balances are different so as we make judgments they should not be combined. China should reduce the trade surplus. In fact, the trade surplus is already dropping gradually. With such a decrease, the Chinese economy can reduce its reliance on the international market. The Chinese government always restricted exporting and expanding domestic demand. China took this action in order to reduce its economy’s reliance on external economies, create more opportunities for foreign companies, and support the job market abroad. However, the portion of investment returns in the current account balance is different in nature from the trade surplus. The imbalance due to investment returns exists simply because of the stock of high currency reserves, which does not reflect on-going macroeconomic imbalance. More importantly, it is a sign that China has made more contributions to the world economy when Chinese companies go abroad and earn higher returns than in China. China, making investments abroad and conducting capital operations efficiently, promoted the employment of the target countries such as Australia, Germany and the U.S. In this way, why should we mix the investment returns and trade surplus, and consider the current account balance in judging the responsibilities of the Chinese economy to the world? Therefore, China needs to explain the above point to foreign experts and officials. China should convey to the world the fact that the ratio of trade surplus of China over GDP is decreasing. It is a practical goal for China to set the upper limit of 2 percent for the trade surplus ratio but not for the current account ratio. China contributed tremendously to the rebalancing of the world economy, which is a point that China has not put much emphasis on.

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li daokui 2. Preserving the Stability of the International Financial System

The second issue that China should take responsibility for is maintaining the stability of the international financial system. Actually, China has already produced some achievements in this area. In today’s world, the developed countries are going through a hard and long process of adjustments during which the credit of developed countries will gradually decrease. A perfect example is the negative outlook of the US Treasury bills. In this macroeconomic environment, many international investors are asking the same question: How can they transfer US dollar-, euro-, and Japanese yen-denominated financial assets to RMB-denominated assets? They have a simple but proper reason for their judgment. If the credit of the US government decreases, the same will happen to the international status of the US dollar. The case is similar in Japan. If the Japanese government holds too much debt, the international status of the Japanese yen will definitely diminish in the long run. When the credit of a country deteriorates, the nominal interest rate will go up, or inflation will occur, causing the devaluation of the fiat money. The international financial situation will go through severe shocks, and this will cause sharp decreases in the exchange rates of the US dollar, euro, and Japanese yen. Note that this is an outlook for the long-term economic situation rather than a short-term prediction. If a large number of international investors intend to change the structure of their asset portfolio and switch their current financial instruments to RMB-denominated assets, the financial system may suffer from intensive shocks. China has to make a difference in this difficult process, and it has actually already done so. For example, after the financial crisis in 2008, China did not draw back its investment in the US Treasury bills when the US financial market downturned. Similar cases are seen in China’s support for the Japanese market. Japan has such a high-level government debt that, when divided by the population, the government debt is equal to 100,000 US dollars per person. Japan is in need of international support in the long term, and China is always providing support to Japan by increasing its holdings of Japanese debt although Yen-denominated debt may go through potential devaluation caused by the poor fiscal situation of Japan. China played an active role in stabilizing the international finance situation. However, China is not good at delivering this message to the world. Another hot topic is the exchange rate of the RMB. Unlike many other currencies such as the Japanese yen and the Singapore dollar, the exchange rate of RMB against the US dollar did not continue to depreciate for a period of time after the financial crisis. As a result, China made contributions to the stabilization of the US financial system. In recent periods, the

1-Jan-05 1-Jun-05 1-Nov-05 1-Apr-06 1-Sep-06 1-Feb-07 1-Jul-07 1-Dec-07 1-May-08 1-Oct-08 1-Mar-09 1-Aug-09 1-Jan-10 1-Jun-10 1-Nov-10 1-Apr-11 1-Sep-11 1-Feb-12 1-Jul-12 1-Dec-12

9 8 7 6 5 4 3 2 1 0

1-Jan-05 1-Jun-05 1-Nov-05 1-Apr-06 1-Sep-06 1-Feb-07 1-Jul-07 1-Dec-07 1-May-08 1-Oct-08 1-Mar-09 1-Aug-09 1-Jan-10 1-Jun-10 1-Nov-10 1-Apr-11 1-Sep-11 1-Feb-12 1-Jul-12 1-Dec-12

the rich, the poor, and china

Chinese yuan/USD (left axis)

Chinese yuan/USD (left axis)

Singapore dollar/USD (right axis)

Graph 3.2. Exchange Rates of RMB and Singapore Dollar

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140

120

100

80

60

40

20 0

Japanese yen/USD (right axis)

Graph 3.1. Exchange Rates of RMB and Yen

9 1.8

8 1.6

7 1.4

6 1.2

5 1

4 0.8

3

0.6

2

0.4

1

0.2

0

0

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RMB has been going through a steady process of appreciation, rather than sharp depreciation or appreciation as seen in other countries. In short, the RMB is a stable currency that provides great support for the stabilization of the international exchange market. There is no doubt that the exports of Chinese enterprises would be better off if the RMB depreciated by more than 15 percent against the US dollar, just as the Korean won, Japanese yen, and Singapore dollar did. And in that case, the world economy would definitely suffer more. China really has done much for the world economy. The communiqué after the first round of the Sino-US strategic economic dialogue states that the US noted that the non-depreciation of the RMB against the US dollar during the financial crisis did support the world economy. However, China’s own media did not report this and no one noticed it. China has done a lot but speaks too little. 3. Promoting the Key Reform of the International Financial System The third issue is to promote the reform of the international financial system. Research on the reform of the international financial system is limited.2 The policy makers should conduct more research and open their minds, which will help them understand the problem well and head in the right direction. The key reform regarding the international financial system is that the proportion of each currency, bond, and equity in the international financial system should be well matched to the proportions of the real economy in the world. In other words, the core status of the US dollar, euro, and Japanese yen will decline gradually in the near future.3 The tendency is that the importance of the emerging-markets currencies will increase. As one of the important emerging-markets currencies, the status of the RMB is rising in this process, which contributed to the stability of the world economy.4 2 There are more details about the reform of international financial system, see David D. Li, 李稻葵, “zhongguo canyu guoji jinrong xin’geju de zhengce fenxi 中国参 与国际金融新格局的政策分析 [China’s Role of Promoting the Reform of International Financial System and the Policy Analysis],” China Finance, 22 (2008), 38–39. 3 David D. Li and Yin Xingzhong 李稻葵、尹兴中, “guoji huobi tixi xin’jiagou: houjinrong weiji shidai de yanjiu 国际货币体系新架构: 后金融危机时代的研究 [The Evolution of the International Financial System after the Financial Crisis],” Journal of Financial Research, vol. 2 (2010), 35–47. 4 David D. Li and Liu Linlin 李稻葵、刘霖林, “renminbi guojihua:jiliang yanjiu ji zhengce fenxi 人民币国际化: 计量研究及政策分析 [The Internationalization of RMB: Measurement and Policy Analysis],” Journal of Financial Research, 11 (2008), 5–20.



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Before the financial crisis, the international financial system was unstable because the US dollar bore almost all international financial investments and international trade settlements, which was not proportionate with the real economy. Once there is a problem with the US economy, the world economy is affected and fluctuates dramatically through financial markets, which is unreasonable. Due to the large amount of US government bonds China holds, China does expect that the decline of the US dollar will be gradual, not rapid. What should China do concerning the process of RMB internationalization? The currency swap agreements among Asian countries help a little in the internationalization of RMB. Two critical factors closely related to the domestic reform should be settled. The primary step of promoting RMB internationalization is to steadily increase RMB-denominated, high-quality financial assets. Global and regional financial organizations and international investors should be encouraged to issue more RMBdenominated assets to improve their portfolio management. In addition, as investors expect the RMB to appreciate, it can also help to reduce the financing costs. At the same time, the further expansion of certain types of RMB-denominated financial assets can increase the RMB’s international status and play a key role in improving its international image, achieving a win-win situation. So, the most critical step is to increase the amount of RMB-denominated Treasury bonds both inside China and abroad, and at the same time, actively explore the introduction of local government bonds and company bonds—for example, China Mobile and China National Petroleum Corporation (CNPC). This is of vital importance.5 China must be careful in this process. International investors should supervise RMBdominated assets because the price volatility of the RMB-dominated assets will be more difficult to predict, which will create more dependency than before on foreign demand. Due to the volatility of assets, the profits of enterprises, and the exchange rate, the macro economy would be substantially affected. So it is very important to create high-quality RMB-denominated financial products under strict regulation. China’s financial system reform, capital market development, and RMB internationalization are closely related to China’s international responsibility. Hence, China must improve the 5 Hong Kong is one of the important international financial centers for RMB-dominated assets, see David D. Li, and Liu Linlin 李稻葵、刘霖林, “shuangguizhi tuijin renminbi guojihua 双轨制推进人民币国际化 [Dual system for the internationalization of RMB],” China Finance, 15 (2008), 37–38.

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quality and stability of its financial institutions, markets, and products to prevent excessive volatility in the short term. Equally important is the management of China’s foreign reserve assets. As more and more international investors invest in RMB financial assets, they have to convert other currencies to RMB. As a result, domestic financial institutions and households will hold more foreign currencies, and that poses great challenges for the management of China’s foreign reserve assets, which are already the largest in the world at more than 3 trillion US dollars. The best way to solve this problem is to encourage domestic enterprises, households, and financial institutions to invest abroad. To promote outward investment, China has to make it convenient. For example, in the future, an investor could easily ask his or her agent in a commercial bank branch in Beijing or Shanghai to help him or her to buy stocks or other financial products in foreign markets. RMB internationalization will not be successful if there is no two-way capital flow between RMB assets and other currency assets. RMB internationalization is more a result of the international community’s demand rather than the requirements of the Chinese people. The international community wants the RMB to be an international currency and to have large amounts of RMB-denominated financial assets. So what is the biggest challenge during this process? China does not have enough intelligent domestic investors and institutions to assure that the return of its outward investment would be higher than foreign investment in China. If China can get higher returns from outward investment, RMB internationalization can bring real benefits to the Chinese people. That is what America has done during the process of US dollar internationalization. By doing simple calculations, we would find that America’s outward investment return is much greater than China’s. To sum up, for China to take international responsibility and satisfy international society’s call for financial stability, it has to be well prepared and take care of its own business. This means imposing higher requirements for education and human capital cultivation in Chinese universities. Graduates should not only know how to work within domestic financial markets and enterprises, but also learn to help domestic households and enterprises to invest abroad and obtain higher returns to exceed foreign investment in China. When this happens, China will gain a firm foothold on the international stage.

CHAPTER FOUR

Understanding the Changing Relations between China and its Neighbors Zhang Yunling* Abstract: China’s relationship with its neighbors has had a significant impact on the country’s development environment. Against the backdrop of China’s rise, the situation in the surrounding areas has also changed. As it could easily be put into the spotlight regarding regional confrontations, China needs to renew its understanding of the new situation and make a sound judgment. There is now a fundamental change in the situation of its surrounding regions, and China’s rising power increases its ability to build a favorable environment for its development. In the coming years, the most important part of its strategies regarding its relationship with its neighbors is to actively promote a stable, peaceful, cooperative, and development-oriented environment and to avoid becoming a “lonely power.” Keywords: Surrounding situation, surrounding relations strategies, surrounding security, ASEAN

The relations between China and its neighbors are of great importance. China has made great efforts to improve the relationship and build the partnership with its neighbors. Nevertheless, the relations between China and its neighbors have witnessed some changes in the background of China’s quick rise. While China becomes a major market for most of its neighbors and the cooperation among them develops intensively, there seem also emerging concerns from its neighbors on China’s competition and rising power and influence. Especially, with the U.S. “back to Asia” strategy aiming at China and with the rising tensions between China and some Southeast countries and between China and Japan because of the disputes on the islands and exclusive economic zones (EEZ) in the South China Sea and the East Sea, China is facing a new regional situation that may greatly affect China’s foreign relations and the development environment. How does one analyze and understand such changes? How does one * The Chinese version of this article was first published in Guoji jingji pinglun 国际 经济评论 [International Economic Review], 1 (2012). Zhang Yunling is academician of the Chinese Academy of Social Science and Director of the International Studies Division of the Chinese Academy of Social Sciences. His email address is [email protected].

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comprehend the overall situation in China’s surrounding areas? Focusing on these questions, this article will offer some analyses and viewpoints on China’s relationship with its neighboring countries. Ι. Evolution of the Relations China is one of the few countries in the world that has so many neighboring countries (14 with land borders and 6 with sea links) with many historical disputes left over. Such a situation makes China’s relations with its neighbors vulnerable in several aspects:1 First, since the situation in China’s neighbors changed significantly, there are uncertainties in their relations with China, with some being hostile toward China. Second, their disputes with China are complicated, involving territorial, historic, maritime, humanistic, and other issues, which easily become irritated. Third, their situation changes with the rise and fall of Chinese power, especially now, when China’s powerful rise is triggering complex responses by its neighbors. One of the key features for China’s relationship with its neighbors is that both China and its neighbors have to adjust themselves in a new context of changing economic, political and security environment. Neighboring relations and its surrounding areas have always been extremely significant for China’s development. Long after the founding of the new People’s Republic, security threats against China mainly came from its surrounding areas, ranging from the confrontation of the Cold War, the Korean War, China-Soviet Union split to border clashes with India and Soviet Union, which forced China to be involved.2 Since its opening-up and reforms, China has made strenuous efforts to change its passive situation, shifting its primary attention to the construction of a peaceful and stable international environment. For that purpose, China focused on improving its relations with the West. With Sino-US détente as the key, China rapidly improved relations with neighboring countries that were close to the US. Thus, greatly relieving China of security threats while expanding China’s room to develop its relations with its neighbors. After the end of the Cold War, China adopted an active policy to normalize its relations with Russia and other states newly independent from

1 Wang Gungwu, “China and Southeast Asia,” in Power shift-China and Asia’s new dynamism, ed. David Shambaugh (Berkeley: University of California Press, 2006), 198. 2 Ye Zicheng 叶自成, 2001, Xinzhongguo waijiao sixiang 新中国外交思想 [Thoughts of New China’s Diplomacy] (Beijing: Beijing University Press, 2001), 151.



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the former Soviet Union. Meanwhile, it mended and improved relations with countries that had been close to the former Soviet Union. By the end of the 1990s, China normalized relations with all of its neighbors. For the first time, China was in a new environment of having no “enemy states” adjacent to it, demonstrating a significant change after the founding of the new China.3 Since 1990s, China has made three major efforts to improve and strengthen the relationship with its neighboring countries. First, China endeavors to solve border disputes with other states. Therefore, it successively delimited land boundaries with newly independent central Asian countries, Russia, and Vietnam while demarcating sea borders with Vietnam in the Gulf of Tonkin (Beibu Bay), and starting active dialogue with India on border issues. Second, China engages in constructing non-confrontational, non-aligned strategic partnerships with other states, advancing the development of overall relations with them. Forming partnership between China and its neighbors helps them to reduce the antagonism and to build up new relations based on sharing interests. Third, China actively participates in and promotes regional cooperation. By participating in and promoting such arrangements as the China-ASEAN Framework Agreement on Comprehensive Economic Cooperation, multilevel East Asian cooperation mechanisms (for example, ASEAN +3, East Asia Summit), the Shanghai Cooperation Organization (SCO) as well as the Six-Party Talks, China formed a new pattern of relations with its neighboring states based on the principle of win-win in their development.4 Due to its rapid economic growth, China provides more “public goods,” for example, as the major market for their exports and imports, for its neighboring countries. Funds and cooperative projects offered by China have also increased by big margins because China is the first or second trading partner for most of its neighbors. Therefore, the two sides have formed important bases for sharing benefits. Meanwhile, via multiple cooperation platforms, China engages in dialogue, consultations, and development coordination with its neighboring states. During such

3 Zhang Yunling 张蕴岭, 2007, “Zhongguo yu lingguo de xin guanxi 中国与邻国的新 关系 [Developing New Relations between China and Its Neighbors],” Journal of Contemporary Asia-Pacific 11 (2007), 3. 4 Zhang Yunling 张蕴岭, Zhongguo yu zoubian guojia—Goujian xinxing huoban guanxi 中国与周边国家—构建新型伙伴关系 [China and its neighbors: Making New Partnership] (Beijing: China Social Sciences Document Press, 2008), 7–10.

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changes, China gained more initiative and influence when handling relations with its neighbors. China’s successful experiences could be generalized as the following: First, China has taken initiatives to build a good environment conducive to peace and development in the neighboring areas. Great progress has been achieved in solving border disputes, easing tension in conflicts and conducting dialogue and coordination between China and its neighboring countries. Second, China’s neighbors responded positively to its efforts and welcome China’s positive role because they hope to take the opportunity and benefit from China’s development out of their own interests. Therefore, the improvement in China’s neighboring relations and the strengthening of coordination over the past years have been made possible because both China and its neighbors are enthusiastic in promoting and benefiting from such interaction and cooperation.5 II. New Changes In recent years, China’s relations with its neighbors and its adjacent areas acquired new and important changes. Three elements mainly reflect these new developments. First, some disputes heated up, with tension in the South China Sea becoming the new hot-spot issue. There are two aspects in the heated South China Sea disputes. One concern is a regional issue: maintaining the stability and security of international waters. The other relates to the sovereignty of islands and reefs and the development of resources there. The former aspect involves countries outside the region, whereas the latter mainly involves disputes with countries such as Vietnam and the Philippines. Since Vietnam and the Philippines attempted to link these two issues together, making the South China Sea issue increasingly internationalized. As a result China has been put into an awkward situation-dealing with the disputed countries on the one hand and handling the external concerns on the other hand. Second, there has been a “quasi consensus” among some of China’s neighboring states that boosts the formation of certain complicated “quasi-alliances” targeting the “mighty China.” Some countries try to take

5 Wang Guanghou 王光厚, 2007, “Cong muling dao muling,anling,fuling—shixi zhongguo zoubian waijao zhengce de zhuanbian 从“睦邻”到“睦邻、安邻、富 邻”——试析中国周边外交政策的转变 [From friendly neighbors to friendly, stable and prosperous neighbors],” Foreign Affairs Review, 3 (2007): 15, 38–43.



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the opportunity to pursue “multi-directional equilibrium”. Although they have different interests, striving for varied objectives, they share common ground in confronting challenges from a powerful China. The new situation restrains the development of China’s new goal to construct a favorable surrounding environment. Third, regional coordination has witnessed changes as well. Since the end of the 20th century, East Asian states have actively promoted regional cooperation without the interference or involvement of the United States. China increased its national influence through active participation in such collaborations. However, maturation of East Asian cooperation encountered some bottlenecks due to some complicated reasons. While some countries in this region keep alert to China’s increasing role, the US has shifted their attention to Washington through leading negotiations on the Trans-Pacific Partnership (TPP), and redesigned the mechanisms and track of East Asian cooperation by joining the East Asia Summit (EAS). Under the circumstances, the furthering of East Asian cooperation is facing a new situation and new challenges. One distinct feature of these new changes is that past conflicts and hotspot issues mainly involved other countries. Although many of them had relations with China, China was not the focal point of any conflicts. For example, interactions between other states caused the Korean Peninsula issue and Vietnam’s invasion of Cambodia. At present, the situation has changed, since China became the focus of certain confrontations. Meanwhile, activities of the US are salient along with these changes. The US felt that the rise of China’s power and influence threatened the US’s leading role and national interests in the Asia-Pacific and Asia. Therefore, the US started shifting its strategic and deployment focus. The US’s strategic priority is to “meet the challenges of China’s rise,” with the key objectives of containing the spread of Chinese power and influence while preventing China from either replacing or weakening US presence and influence in Asia. On one hand, the US openly declares a “return to Asia” aiming to increase its involvement in Asian affairs; on the other hand, Washington puts emphasis on “the Asia-Pacific Century,” with the hope of highlighting the US’s dominating status and leading role in Asia. In 2009, the US put forward the policy of “returning to Asia,” starting to focus more on East Asia strategically while distributing more diplomatic and military resources to areas adjacent to China. Through investing more in China’s surrounding areas and utilizing its multi-level relationship mechanisms, the US vigorously weaved a network to cope with “a mighty China.” Such activities cater to the needs of some Asian countries that attempt to rely

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on the US’s involvement to put pressure on China and increase their abilities to tackle challenges from “a mighty China.”6 Such new developments have not only brought danger and uncertainties to hot-spot issues surrounding China, but these events also disturbed China’s security with neighboring countries that it worked so hard to improve for years. Thus China’s foreign policy faces new challenges concerning its neighbors. III. Understanding the Changes The new developments demonstrate that both the structure and situation of China’s neighboring relations have undergone new changes. Therefore, we must have new understanding and attach great importance to it. Hence, it is very important to make sound judgments about the new situation. The first judgment is that there has been no fundamental change in the nature of the relations between China and its neighboring countries since the disputes are only in limited areas, with few countries and no an alliance against China. Although the US and many of China’s neighboring states adopted the approach to tackle “a mighty China,” there are multiple implications. China’s neighbors, along with the US, do not intend to engage in full-scale confrontations against China, nor do they seek to fully limit China’s strategic maneuvering space. The second judgment is that although China has been compelled to react passively to these new changes, China’s capability of proactively shaping a favorable environment increased greatly due to the rise of its power. Those neighboring states, including some in dispute with China, increasingly depend on China’s market. China and its neighbors recently formed strong mutual “development interests,” and China’s role is irreplaceable. Maintaining stability, peace, and development momentum has become an important consensus between China and its neighbors. Under such circumstances, it is crucial for China to make full use of its advantages, and highlight the mutual development interests it shares with its neighbors while keeping calm and rational instead of falling into disarray. Grasping the overall situation of Sino-US relations remains the key issue for China. The dominant strategy of the US is to form a network to contain 6 Cui Tiankai 崔天凯 “Zai zhongmei ‘ergui’ gaoceng duihua disanci huiyi shang de zhici 在中美 ‘二轨' 高层对话第三次会议上的致辞 [Address at the third China-US track two high level dialogue],” Foreign Affairs Journal, 103 (2012): 8.



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and balance China. However, this strategy is mainly “defense-oriented,” which is fundamentally different from US-Soviet confrontations during the Cold War era. Being aware of its economic, political, and security interests relating to China, the US shows restraint when inciting China’s neighbors to contain Beijing. The goal is not to completely sever its ties with China. It is unprecedented that an existing hegemonic power and a rising power have so many intertwined mutual interests as the US and China. “Not having full-scale confrontations” has become the objective for both sides as well as the fundamental equalizer in Sino-US relations. The US, determined to increase its involvement in and influence on Asian affairs, seeks to balance the growth of Asian power by playing the leading role in the Asia-Pacific area. The US will invest more in this approach in the coming years. At the same time, it should be noted that some neighbors of China support or accept US involvement primarily because they could benefit from some “public goods” the US can provide. However, the US is problem-ridden domestically, making it difficult to dominate the Asia-Pacific region on its own. On many issues, the US may find itself unable to fulfill its goals and some of its followers may also vacillate. For China, “dancing with wolves” would be inevitable. One noticeable fact is, since initiating its “War on Terror,” the US greatly reduced its engagement in Asia, especially in East Asia. At the same time, however, regional relations in East Asia witnessed many changes while regional cooperation accomplished much without US involvement. One particular change is reflected in the substantial increase in China’s strength and influence. Such a development poses challenges and threats against the US traditional status and strategic interests, thus triggering alarm and fear in Washington. Concerned that “de-USninzation” may further develop in this region, the US abandoned its previous policies of “acquiescence” or “negligence” and decided to intensify its investment in Asia, aiming to re-establish its status and restore its once lost strategic space. In facing the US’s rapid policy changes and increased involvement in Asia, China worries that the cooperative environment experienced in the past three decades in Asia may turn to strategic competition. Some even affirm that China is facing an unprecedented severe situation because “dark clouds are hanging over its surrounding areas.” However, this appears to be excessive panic and misperceptions not reflecting reality since the US and China have comprehensive interests shared that may prevent them to be confronted. One phenomenon demanding our attention is that, although many Asian countries support certain US actions for complicated reasons, for

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example, as the ally of the US, having dispute with China, or winning the US support etc., their own interests may be impaired if the US over reaches and stirs up confrontations. This is especially true for ASEAN. Since US over-involvement will restrain ASEAN’s ability to shape new regional relations, ASEAN makes painstaking efforts to achieve self-management. In this case, ASEAN will not voluntarily hand over its initiatives to the US. Not long ago, when the US took part in the East Asia Summit, ASEAN members issued the new “Bali Declaration,” emphasizing their intention of playing a larger role in international affairs. This could be perceived as an affidavit of ASEAN’s standpoint. Meanwhile, China and its neighbors formed solid foundations for sharing economic and security interests. This made the latter unwilling to side with the US or China because they worry that US-China confrontations will not only harm their development interests, but also force them into an awkward situation of taking sides. Consequently, ASEAN remains alert to US involvement and seeks to strike a balance between the US and China. China, therefore, ought to work harder in its surrounding areas by readjusting its tactics and priorities as well as promoting mutual trust and pursuing mutual interests in order not to push its neighbors to the US. East Asia remains the focal point for China to safeguard its economic and security interests. A multi-layered cooperation framework has been formulated by China and other countries in the region and progress has been made to maintain regional stability and promote regional consultation and cooperation here. East Asia’s new challenges for the coming years include adapting to such new situations while deepening the above-mentioned cooperation processes. In the economic sphere, the US remains the final major demand market for East Asian exports, and the US dollar still plays the leading role in the world market. The US is qualified to promote high-level institutional opening-up. It has the capacity to provide markets and institutional “public goods” to others, which China is not equipped to do so right now. This is the key reason why so many countries are enthusiastic about participating in the TPP talks. The US engages in economic institutional building by promoting the TPP, and pushes for a deeply integrated open market to highlight its dominant role and seeks for initiatives in the Asia Pacific. Under such circumstances, it is significant for China to vigorously support ASEAN’s endeavor in promoting the East Asia Free Trade Area (not necessarily confined to the “10+3” mechanism—“10+6” could be initiated), hasten the establishment of the China-Japan-Korea Free Trade Area and, especially, advance the formation of the China-ASEAN Economic Development Zone.



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The US and Russia taking part in the East Asia Summits (EAS) has become an undeniable fact. A new challenge China faces is how to establish a cooperation framework engaging the US and Russia. The US takes part in the EAS mainly due to its strategic concerns on its position and role in the regional politics and security. In fact, it is beneficial for China to have big powers such as the US, Russia, India, and Japan along with ASEAN gathering for talks within a regional framework. This is just what China would wish for to some degree. China should take full advantage of this platform to actively create a favorable external environment for its peaceful development. There will be no methodical containment against China in such a framework. Therefore, China should take a more active attitude toward the EAS, making greater efforts to design, participate, and guide its future development. Institutional building on the regional economic integration in East Asia, such as an East Asia FTA, has been progressing slowly over the past few years. Except for the Sino-Japan discord on the structure and approach of the East Asia FTA, ASEAN’s lack of enthusiasm and ability has been another major cause due to its own difficulty on building the ASEAN Community and different views among the members. As the US currently dominates the formation of the TPP, ASEAN may become more proactive in advocating ASEAN integration and East Asian institutional integration out of the concern that it may be marginalized in these processes. ASEAN may harness the US as its model, taking the initiative to build the institutional configuration for a larger regional FTA. ASEAN may invite other East Asian countries to participate in the FTA for the sake of safeguarding ASEAN’s core status, and to prevent the US from impeding ASEAN integration via TPP or challenging its central role in constructing East Asian cooperation mechanisms. ASEAN has shown a strong interest to make a new initiative on negotiating a Regional Comprehensive Economic Partnership (RCEP) based on 5 “ASEAN +1” FTAs (the FTA with China, Japan, Republic of Korea, India, Australia and New Zealand). China needs to utilize this opportunity accompanying the new situation while fully supporting ASEAN’s leading role in order to promote East Asian integration and coordination. It is particularly important for China to form good relations with ASEAN states. ASEAN has the strategic intention and design to cope with challenges China’s rapid development poses. As a whole, however, it still gives priority to conducting dialogue, consultation, and cooperation with China. ASEAN is “wary of China,” but tries to avoid confrontation with it. ASEAN will not serve as the anti-China frontline, nor could it afford to

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be at odds with China.7 ASEAN is located in China’s geo-strategic areas, where China has immediate economic, political, and security interests. Such endogenous interest linkages between the two sides are unique for China. Therefore, China should strengthen its relations with ASEAN, increasing its investments in ASEAN members, especially in less developed countries, such as Laos, Cambodia, and Burma. In addition, based on ASEAN’s Connectivity Master Plan, China should construct direct transport and communication networks with ASEAN states while furthering ASEAN’s integration with and dependence on the Chinese market. Meanwhile, China needs to invest more in cultural and educational fields, accepting more students from ASEAN to study in China while not allowing certain conflicts, like disputes on South China Sea, some argument of “China threat” etc. to sway its overall perceptions of ASEAN. An important issue affecting both China’s foreign relations and its international environment concerns the South China Sea. To safeguard their claims on the islands and Economic Exclusive Zones (EEZ) of South China Sea, Vietnam and the Philippines attempted to invite outside forces, like the US, Japan and India to stir up the issue of so called freedom of marine navigation. However, all parties concerned are conscious that hasty use of military force would be too costly when the timing is not right to resolve the disputes. Thus, maintaining overall stability is the fundamental consensus all parties reached while searching for the solution patiently. To ensure political settlement of the disputes, all parties should actively utilize the ASEAN platform while highlighting their shared interests in order to guarantee overall stability. A significant breakthrough is ASEAN and China signing of the “Declaration on the Conduct of Parties in the South China Sea.” This action demonstrates both sides agreed to handle the issue within the broader framework of Sino-ASEAN relations although the real negotiation of the issue needs to be conducted only between the parties directly involved. China needs to continue making good use of such a framework to ensure overall stability. At present, there is no quick solution to the South China Sea disputes, and this influence will keep fermenting. Under such circumstances, while China should enhance its 7 He Shengda 何胜达, 2008, “Dongmeng duihua guanxi xianzhuang yu weilai 东盟 对华关系现状与未来 [Current Status and Future of ASEAN’s Relationship with China],” in Zhongguo yu zhoubianguojia:goujian xinxing huoban guanxi 中国与周边国家: 构建 新 型伙伴关系 [China and its neighbors: Making new partnership], ed., Zhang Yunling 张蕴岭 (Beijing: China Social Sciences Document Press, 2008): 97.



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intervening power to defend its own interests, it should also to take the active initiative to promote the dialogue and consultation either among the disputed parties themselves, or with the other countries of the ASEAN and also the US. Besides bilateral negotiations, China could also call for all disputed parties to hold informal dialogue or expert talks within the China-ASEAN coordination framework. Different views regarding the South China Sea issue coexist in China while relevant information is ambiguous right now, especially on China’s sovereignty over the whole South China Sea waters. Three major laws have been passed regarding the South China Sea and its islands and reefs in China: the 1992 “Law of the People’s Republic of China on the Territorial Sea and the Contiguous Zone,” the 1996 “Statement of the Chinese Government on the Baseline of the Territorial Sea of the People’s Republic of China,” and the 1998 “Law of the People’s Republic of China on the Exclusive Economic Zone and the Continental Shelf.” These laws clarified China’s sovereignty over the islands and reefs in Nansha, Xisha, Dongsha, and Zhongsha, China’s territorial sea, and sea baseline as well as the exclusive economic zone in the Xisha islands, but the laws do not involve the sovereignty over the whole of the South China Sea’s waters. The issue of ensuring safe navigation in the South China Sea refers mainly to China’s ownership of the whole sea waters. If this is clearly defined, showing disputes mainly involves islands and reefs in the South China Sea, China’s territorial sea, its contiguous zone, and exclusive economic zone, especially islands, reefs, and related waters in Nansha, it would deprive outside forces of any excuse to intervene. Meanwhile, it would also demonstrate China’s position on resolving the disputes according to international laws. This is not the first time that Vietnam and the Philippines provoked disputes in the South China Sea. Both countries engaged in multiple military conflicts with China in the past, but they only involved disputed countries within the region, making it difficult for outside forces to intervene.8 Therefore, it is necessary for China to issue clearer and more accurate explanations on the South China Sea disputes in order to gain the initiative. An “ambiguous strategy” should no longer be adopted since the earlier China makes its position known the more initiative it could seize, helping China grasp the correct timing for resolving the disputes. Publicizing its positions does not mean

8 National Institute for Defense Studies, Japan, “East Asia Strategic Review, 2012,” p. 145.

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China will give up anything voluntarily, since all parties concerned will negotiate to find concrete solutions to the disputes.9 The Korean Peninsula remains a sensitive issue. Over the past few years, one core design of the Six-Party Talks was to solve North Korea’s nuclear problem to help ensure security of the Korean Peninsula and northeastern Asia. The situation changed since North Korea became a nuclear power and will not give up its nuclear program easily. The US may not change its policies toward North Korea but will continue uniting South Korea and Japan in pressuring the North. Taking the North Korea nuclear issue as its excuse, Washington will also seek to consolidate its military alliance with South Korea and Japan to guarantee its leading role on the peninsula.10 Some were previously concerned that North Korea’s nuclear plan would compel Japan and South Korea to follow its steps. Now it becomes clear that the US will not easily allow them to go nuclear. Settling North Korea’s nuclear issue depends on further consolidated efforts made by China, the US and other partners of Six Party Talks. It seems unrealistic to demand North Korea give up its nuclear plan while making this the precondition for resolving the Korean nuclear issue, although a nuclear North Korea is not acceptable. Recently, South Korean citizens have been increasingly concerned about the North-South tension and discontent with President Lee Myung-bak’s policy of “leaning to one side.” There will be a major change of South Korea’s policy toward the North, and the North-South tension will dissipate after the South Korea general election in 2012. The death of Kim Jong-il may offer a good opportunity for compromise as well, since all parties concerned “happen to have the consensus” of ensuring a peaceful transfer of power in North Korea so that security of the Korean Peninsula can be maintained without intensifying conflicts. It is important to nurture a new environment to overcome the current dilemma. Of course, the Korean Peninsula problem contains multiple contradictions for which there is not quick solution. The key, however, is to maintain overall stability on the peninsula. So long as no major confrontations happen in the future, China still possesses extended strategic maneuvering room even if there is no strategic coordination between China and the US. China should make greater efforts in supporting and promoting North

9 Some argued that there emerges a quasi-alliance against China on South China Sea issue that makes China response strongly. 10 Liu Jiangyong 刘江永, “Jin zheng en jiebanhou de chaoxianbandao jushi 金正恩 接班后的朝鲜半岛局势 [Korean Peninsula after Kim Jong Un’s succession],” Foreign Affairs Journal, 103 (2012): 132.



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Korea’s reform and opening-up. Taking North Korea’s leadership transfer as a good opportunity, China should openly express its support and endorsement of North Korea’s progressive reform on its economic system and improvement of its external relations. In addition, by all possible means, China should make North Korea realize the pressure that social disturbances are inevitable if its economy does not grow and the living standards of its people cannot be greatly improved. Moreover, China should support the improvement of the North-South relationship relying on the China-South Korea strategic partnership framework. It has been proved that North-South confrontations on the Korean Peninsula would not only pose substantial negative effects on China’s relations with both sides, but also gives the US a loophole it could exploit. The US’s policies toward North Korea will not experience fundamental changes after the US 2012 general election. Under such circumstances, China should play a more significant role. As an important regional mechanism created under China’s initiatives, the Six-Party Talks need to be retained since they are conducive to safeguarding overall stability here while helping China to strive for strategic initiatives and prevent the situation from developing in favor of other. Of course, corresponding to the changing situation, new initiatives should be introduced to the agenda and means of the Six-Party Talks. Sino-Japanese relations are important, but China and Japan will find difficulty in developing substantive improvements. Historical issues’ influence in Sino-Japanese relations weakened over time, the two countries are in serious conflict over modern interests. It seems that Japan worries more than before about China’ rising power that lets Japan further lean to the US side for its security and encourages Japan to take an active policy on forming a network to retain China’s challenge and influence. However, Japan’s economic growth depends heavily on the Chinese market, and Japanese interest groups hoping to maintain a stable relationship with China are quite influential and pressure the Japanese government. Therefore, Japan will seek “asymmetrical balance,” emphasizing its special linkage with the US on one hand while not totally destroying its relations with China on the other. As a result, Japan’s policies toward China will fluctuate. Even so, China still has much to work concerning Sino-Japanese relations. China should emphasize the importance of a stable relationship of the two countries, and stabilize the relationship rather than allowing disputes such as the Diaoyu Island issue cause a deterioration in their relations or instigate major confrontations. Pertaining to this point, China needs to act cautiously on the dispute while making its intentions clear to Japan.

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China, Japan, and South Korea formed a mechanism for dialogue and cooperation that needs further development. It is particularly important to push forward the China-Japan-Korea Free Trade Area (FTA) after the construction of the East Asia FTA was halted when Japan announced it would take part in the US-led TPP and the US-South Korea FTA was implemented. Since China is relatively less developed compared to Japan and Korea, it should prepare to make a bigger commitment to open its markets when refining the China-Japan-Korea FTA. While the existing dialogue mechanism mainly aims to promote the three’s collaboration on economic and non-traditional security issues, like protecting environment, safety of nuclear power stations, as well as handling the fishing disputes etc., the China-Japan-Korea FTA should help to restructure their economic relations by facilitating investments from China to Japan and South Korea. The Shanghai Cooperation Organization (SCO), conducive to maintaining security in China’s north-western areas, becomes a platform for promoting China’s relations with Russia and other countries in Central Asia. China should invest more resources in all aspects of the organization, enhancing coordination with the SCO. One basic principle guiding the development of the SCO is to make steady progress on ensuring the stability and peace and promoting the economic development of the region. Neither aggressive actions nor reckless expansion of the SCO is suggested for China since it needs time to consolidate and to be enhanced. China should also be very cautious toward US participation in the SCO. Although safeguarding common security has been the starting and focal point of the SCO, promoting economic cooperation to achieve mutual development of its member states remains the foundation for future sustainable development. China should push forward an “SCO connectivity plan” and increase its investment in the Organization since a SCO-FTA may need more time to be put on the agenda. In the coming years, the most important part of China’s strategies regarding its relationship with its neighbors is still to actively promote a stable, peaceful, cooperative, and development-oriented environment. China needs to rely on its continuously rising power and influence to further improve its capacity in comprehending and guiding the overall situation in its surrounding areas. So long as China makes sound judgments regarding its neighboring relations, there will not be an anti-China coalition, nor could China become a “lonely power.”11 11 John Lee from Australia Lowy Institute described China as a lonely power since it has few true allies. Http://www.macrobusiness.com.au/2011/10/chinas-lonely-power.

CHAPTER FIVE

The China Model and World Order Su Changhe* Abstract: During the past six decades, China has gradually formed a systematic and unique model in handling domestic and foreign affairs, in fields including foreign relations, political, economic, and social developments. In the organization of its political and social order, the concept of “cooperation” instead of “checks and balances” is the core spirit of the China model. Such a spirit has been manifested in specific institutional arrangements, such as multi-party cooperation, political consultation, the combination of legislative and executive powers, the United Front, the mixture of diverse forms of ownership, the coexistence of governmental and non-governmental organizations, and the cooperation of domestic politics and international politics. This spirit of cooperation embedded in China’s institutional arrangements diametrically differs from the spirit of checks and balances in the Western political order. The China model demonstrates the Chinese people’s understanding of the domestic order and the world order. As part of human political civilization, the China model can provide necessary ethical and political resources for the organization of the world order. Yet, this process requires a sustainable high-level cooperation between China’s domestic politics and international politics. Keywords: The China model, the Western order, the world order

Ι. A Historical Review of China’s Relation with the World China is a super-large state in terms of geography, population, and societal complexity, the type of its relation with other countries in history had been widely regarded as one of classical regional systems in world history. The founding of the People’s Republic of China in 1949 was a major event in world politics. China’s attitude and actions around the Soviet Union, the United States, and the Third World countries impacted the evolution * The Chinese version of this article was originally published in the Waijiao pinglun 外交评论 [Foreign Affairs Review], 4 (2009), 21–31. Su Changhe is Professor and Deputy Dean of the School of International Relations and Public Affairs at Fudan University. He is also the Executive Director of the National University Institute of International Politics; the Executive Director of China United States Society; and the Director of the United Nations Association of China. His email address is [email protected].

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of Cold War politics after the end of World War II. Immediately after the founding of the People’s Republic of China and since the late 1960s and early 1970s, China’s choices and actions influenced its relations with the rest of the world in the following three ways. During the late 1960s and early 1970s, China was one of the key factors in breaking through the Cold War system. As a socialist country, the improvement and normalization of China’s political relations with the United States and other Western countries helped to break the rigid Cold War system and accelerate the end of the Cold War. Seen from the international Cold War history, China was one of the driving forces that ended the old Cold War order and its dynamic role during this process could be described as at least critical, if not decisive.1 The second major decision was the reform and opening-up strategy that began in 1978. This marked the beginning of the era of comprehensive cooperation between China and the international economic system that brought about historical changes in China’s relations with the world economically. Since then, the interdependence between China and the world economy sharply increased. China and the world economy are inseparable. Seen from the relations among socialist countries, China is the most courageous socialist country in terms of breaking the socialism dogma and is also the first socialist country that carries out extensive cooperation with the international economic system. Such practice has enriched and developed socialism. The third major decision is shown in the speeches delivered by President Hu Jintao (胡锦涛) on occasions such as the 60th anniversary of the founding of the United Nations General Assembly, the Yale University2 visit, and the 17th CPC National Congress. Those speeches express an idea of building a harmonious world of lasting peace and common prosperity, and state China’s ethical and political stand on the world order.3 The idea of

1 Zhang Shuguang 张曙光, Jiechu waijiao—nikesong zhengfu yu jiedong zhongmei guanxi 接触外交—尼克松政府与解冻中美关系 [Diplomatic Contact: The Nixon Administration and Milestone in Sino-US relations] (Beijing: World Affairs Press, 2009), 319. 2 Hu Jintao’s speech at the Summit Meeting on the 60th Anniversary of the United Nations, “Nuli jianshe chijiu heping, gongtong fanrong de hexie shijie—zai lianheguo chengli 60 zhounian shounaohuiyi shang de jianghua 努力建设持久和平、共同繁荣的 和谐世界—在联合国成立 60 周年首脑会议上的讲话 [Making Great Efforts to Build a Harmonious World with Long-lasting Peace],” http://news.xinhuanet.com/world/200509/16/content_3496858.htm; Hu Jintao’s speech at the Yale University, http://www .chinanews.com.cn/news/2006/2006-04-22/8/721041.shtml. 3 Hu Jintao 胡锦涛, Gaoju zhongguo te se shehui zhuyi weida qizhi wei duoqu quanmian jianshe xiaokang shehui shengli er fendou—Zai zhongguo gongchandang di shiqici quanguo daibiao dahuishang de baogao 高举中国特色社会主义伟大旗帜 为夺取全面建设小 康社会新胜利而奋斗—在中国共产党第十七次全国代表大会上的报告 [Hold High



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a harmonious world is the combination of Marxism with China’s national conditions. It embodies a wealth of ethical, ideological, institutional, and cultural resources that could contribute to the construction of the world order. Working with China’s increasingly powerful material resources, this idea will have an important impact on the evolution of world political order. As for the scale of such an impact, it’s still too early and it would be hasty to make any final conclusion for the future. Since the founding of the People’s Republic of China, particularly the reform and opening up policy in 1978, China has accumulated some unique experiences in its dealings with the world. These experiences provide the basis for the peaceful co-existence and common development of China and other nations. The first experience is through domestic institutional innovations, China mitigated many negative effects on world politics caused by its own development. This helps reduce negative extraterritorial effects on world politics and maintain China’s cooperation with the outside world to the utmost extent, and secure a peaceful international environment for China’s domestic development. China’s path to modernization unswervingly follows the policy of independence and self-reliance. During the process of China’s industrialization from 1952 to 1978, China established relatively complete and independent industrial and national economic systems mainly through domestic efforts,4 except for its heavy dependence on Soviet aid during the “First Five-Year Plan” period, but it is worth noting that China never joined the Council for Mutual Economic Aid (CAER),5 which represented the socialist economic system. From 1978 to 2008, participation in the international market economy, trade and investment became an important factor in

the Great Banner of Socialism with Chinese Characteristics, and Strive for New Victories in Building a Moderately Prosperous Society in all Spects—A Report from the 17th National People’s Congress of Communist Party of China] (Beijing: People’s Press, 2007), Part. 11. 4 Hu Angang 胡鞍钢, Zhongguo zhengzhi jingji shilun 中国政治经济史论 (1949–1976 年) [On China’s Political and Economic History-From 1949 to 1976] (Beijing: Tsinghua University Press, 2007), 692–702. 5 Shen Zhihua 沈志华, “Lulian daguimo yuanhua yu zhonggong dui sugong de zhichi 苏联大规模援华与中共对苏共的支持 [History of Sino-Soviet Relations, Soviet’s LargeScale Aid to China and Chinese Communist’s Support of Soviet Communist],” in The History of Sino-Soviet Relations ed. Shen Zhihua 沈志华 (Beijing: Xinhua Publishing House, 2007), 168. Zhou Hong, Zhang Jun, Zhang Min 周弘, 张浚, 张敏, Waiyuan zai zhongguo 外援在 中国 [Foreign Aid in China], (Beijing: Social Sciences Academic Press, 2007), Chapter 2. “The First Five-Year Plan” was implemented during 1953–1957, which was to realize the socialism industrialization.

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boosting China’s economic growth. However, China didn’t dominate the international economic systems then, and it was impossible for China to take advantage of international institutions to transfer its domestic negative factors to the international community. This strategy for China’s modernization determines that China has to shoulder greater pressure than those countries that relied more on expansion to achieve modernization in earlier colonial times, and it also means that China wouldn’t launch frequent wars of expansion as those major powers did during the modernization race in the 19th century. The major reason contributed to it is the self restraint factor which is embedded in China’s political system. The second experience is that since 1978 China achieved its modernization through a moderate way of cooperating rather than confronting the international systems. Yet, as mentioned earlier, China’s non-dominant role in international systems enables it to reap the benefits of globalization, but it also places China under considerable self reliance situation. As a leader in the modernization wave, China cannot easily achieve its industrialization through the way of external war and plundering resources as the early capitalist countries did. It means that China must take the way through domestic institutional innovations rather than external expansions. From the records of how China complies with the international institutions, China is one of the countries that most scrupulously abide by the international institutions and international laws. Such a compliance quality is inseparable from China’s unique political and economic system, and from China’s foreign relations featuring peaceful development, cooperation, and dialogue. By following international institutions, China’s development hasn’t brought about turbulence to the international system as other emerging powers, such as Japan and Germany, did in the late 19th and early 20th centuries when they tried to challenge and reform the international system. In contemporary world politics, reforms of international systems become a major trend. China’s attitude toward the reform of international systems puts more emphasis on supplementation, incremental improvement, and consultation instead of total negation and radical revolution. The third experience is that China’s development focuses more on coordination of internal and external politics. China perceives its relations with the world from the perspective of cooperation of domestic and international politics, and common progress. In the era of globalization, the interaction between domestic and international politics has shown that the more isolated these two types of politics are, the poorer the relation is, and the more difficult it is to tackle domestic or international problems.



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What’s more, the crisis of the international system would spread to the domestic system, and the deterioration of domestic issues would accordingly endanger the stability of the international system. On the contrary, the more cooperative the two politics are, the more rapidly their problems transmit to each other, and the more likely for a country to seek solutions of its problems from the perspective of overall interests. In addition, as some scholars proposed, China promotes the interaction between domestic politics and international politics through a way of “changing itself and then affecting the world.”6 And as it will be explained later, China’s domestic political and economic progress create favorable domestic conditions for China to interact with the world, and China’s domestic reforms drive it to take more actively participate, support, and transform the international political and economic reform. If China had not domestically reformed, the world would find it difficult to accept China.7 Similarly, an unreasonable international political and economic system is not conducive to the solution of China’s domestic problems. Thus, it can be concluded here that China is a major power in promoting multi-polarization of the world and democratization of international relations. II. China’s Model: Inspiration from Domestic Politics China is a socialist country, and Marxism is the ideological basis of China’s political and economic system. Of course, this political and economic system cannot be separated from the Chinese tradition and current national conditions. From the perspective of comparative political economy, after over 60 years of development, China’s political and economic system gradually accumulated ​​some unique practices that became part of the human political civilization and also provided the domestic institutional foundation for China’s peaceful development toward modernization. First, with regard to China’s political system, it has several unique elements that help to maintain a stable domestic order for the country’s 6 Zhang Baijia 章百家, “Gaibian ziji yingxiangshijie—20 shiji zhongguo waiijao zouyi 改变自己, 影响世界­­—20 世纪中国外交基本线索刍议 [Changing Oneself and Affecting the World—A Basic Clue of Chinese Diplomacy in 20th Century]” Social Sciences in China, 1 (2002), 4–19. 7 Su Changhe 苏长和, “Guonei- guoji xianghu zhuanxing de zhengzhi jingjixue: jianlunzhongguo yu guojitixi de guanxi 国内-国际相互转型的政治经济学: 兼论中 国与国际体系的关系 [Domestic-International Mutual Transformation of Politics and Economy—On the Relationship between Domestic Change and International System]” World Economy and Politics, 11 (2007), 6–13.

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modernization: (1) People’s Congress and political consultative system rather than the system which mostly dependent on competitive interest groups especially capital interests groups; (2) Cooperative rather than competitive political party system; (3) Electoral system that combines elections and recommendations; (4) As to military-political relations, China’s powerful ruling party and its leadership over the army have excluded the possibility of frequent military interventions in political affairs which plague many developing countries during their process of modernization. This is one of the completely different political ecologies that China enjoys when compared with other developing countries.8 This special political-military system is inseparable from China’s time-honored political culture of “civil administration” and “ruling without army.”9 China’s national system is unique in that it’s the unitary system that combines the system of regional autonomy for ethnic minorities and Special Administrative Region (SAR) system.10 The “one country, two systems,” in particular, is an innovative endeavor in China’s national system. Generally, this unique national system is more or less understood from the perspective of domestic politics, but when viewed with the larger context of domestic-international politics, this kind of system that integrates the spirit of diversity and unity is an ideal model for the establishment and governance of large-scale geo-politics. This spirit is consistent with ancient China’s thinking on Asian order.11 Second, from the perspective of the economic system there are four major points: (1) China has adopted the basic economic system of keeping public ownership as the mainstay of the economy while allowing diverse forms of ownership to develop side by side. On the one hand, the State’s control over large State-owned enterprises helps to improve the national   8 On the intervening role of the military groups in political development in some developing countries before 1960s, see John Johnson, ed., The Role of the Military in Underdeveloped Countries, New Jersey: Princeton University Press, 1962. See also Chen Mingming 陈明明, Suoyou De Zidan Douyou Guishu 所有的子弹都有归属: 发展中国家军人政 治研究 [All Bullets Have Their Targets: A Study of the Military Politics in Developing Countries] (Tianjin: Tianjin People’s Publishing House, 2003).   9 Xu Zhuoyun 许倬云, Qiu gu bian 求古编 [Qiu Gu Bian] (Beijing: Beijing New Star Press, 2006), 11. Lei Haizong 雷海宗, Zhongguo de bing 中国的兵 [Soldiers of China] (Beijing: The Commercial Press, 2005), 89–147. 10 Pu Xingzu 浦兴祖, Dangdai zhongguo zhengzhi zhidu 当代中国政治制度 [Contemporary Chinese Political System] (Shanghai: Shanghai People’s Publishing House, 1999), 596–601. 11  Yang Liansheng 杨联升, Guoshi tanwei 国史探微 [An Exploration on Chinese History] (Beijing: New Star Press, 2005), 92.



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macro-control capacity and ensure that the state has sufficient power to determine the direction of economic development. However, an economic system that allows the existence of a non-State-owned economy can activate competition and improve efficiency; (2) China’s broad-based democracy (demonstrated in the People’s Congress System and political Consultative System) rules out the possibility of domination over political affairs exerted by the capital-oriented democracy and capital power. Thus, it limits the possibility that some small number of large enterprises or financial companies’ lobbyism would hinder the interests of national development. As we all know, interest groups are the cancer of any politics. There are countless examples of businessmen harming the national long-term interests for the sake of individual short-term interests. The combination of business and political power often disrupts the national macro-strategic plan. China’s socialist political system ensures that the businessmen’s influence will not rise to the point of controlling the State power. This feature is determined by China’s socialist political system, but is also the result of historical choice. In other words, it’s closely related to China’s traditional economic ethics of capital regulation. In this sense, China’s peaceful development is based on a strong economic system. That is to say, China will not have to depend on the model of alliance of commercial, political, and military power, which appeared in the modernization race during the late 19th century. It thus rules out the possibility of achieving modernization by foreign military expansion; (3) With respect to the relationship between economic growth and the political system, China doesn’t regard the Western competition-oriented democratic system as a necessary condition to achieve economic growth. And China promotes its economic democracy through the growth of individual freedom of choice and the introduction of a market competition mechanism; (4) China’s socialist market economic system participates widely in the global economic system rather than remaining isolated. Thus this system is completely different from the socialist market system within the socialist camp during the Cold War.12 In addition, the State’s leadership over the large State-owned enterprises enables it to have sufficient capacity when it wants to take action to implement a fair redistribution policy.　

12 On the market socialism during the Cold War, see especially the chapter Three of the socialist market economy, Morris Bernstein 莫里斯·博恩斯, Bijiao jingji tizih 比较 经济体制 [Comparative Economic Systems], Tran. Wang Tiesheng 王铁生 (Beijing: China Financial and Economic Publishing House, 1988).

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Third, from the perspective of social development, since the founding of the People’s Republic of China, especially since the reform and opening-up policy in 1978, a large number of institutional innovations in social fields helped relieve social pressure through domestic endeavors. The social pressure has been reduced to the level that will not hinder the political and economic reform. Over the past 30 years, China has achieved economic growth that might take other countries several hundred years to achieve. However, the faster the process of modernization is, the faster the accumulation of social problems. Social pressure thus urges the ruling party to solve social problems in a shorter time. This is a difficult task for the Communist Party. China has already accumulated many unique institutions and experiences in the fields of social development, such as family planning and transformation of population reproduction, the public health system and the health improvement of urban and rural residents, the popularization of education and the rapid decrease in illiteracy, the urbanization model and the system of poverty reduction, the food problem solution model, the social relief system, the comprehensive management of social safety, and the government-social organizations cooperation relationship, to name just a few. These institutions are not perfect. Some have been roughly established while some are still in incubation, but they have one thing in common: China tackles these problems mainly through domestic efforts and makes a great effort to reduce the proliferation of such problems to the international system. However, successful stories in these fields of social development are not the core concern. What we need to think about deeply is that national power cannot handle all those problems alone and there must be some solid social force, or some unique state-society model to ensure that a country of such a large scale can cope with all these social problems during the rapid modernization process. Then what on earth is China’s unique state-society relation? I think there are two points worthy of our attention: First of all, the state-society relation in China has experienced a slow evolution from the “strong-state and weak-society” model to the “strong-state and strong-society” model. Before the late 1970s, the state’s control was everywhere and social vitality had been more or less suppressed. “People’s desire” and “people’s wisdom” were both suppressed.13 13 In the sense of political ethics, I personally believe that a successful political system can on the one hand inspire public wisdom, and on the other hand guide the public desire, preventing it from undermining the political order. In other words, the ethical function of political system is to “inspire public wisdom” and “guide public desire.” Since the



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The reform and opening-up wakes up the sleeping social forces, just as President Hu Jintao said in a speech to commemorate the 30th anniversary of China’s decision to take a more active role in the world’s affairs. He mentioned that an important experience of the reform and opening-up is that it enlightens each person’s wisdom: “Actively explore systems and mechanisms that can greatly emancipate and develop social productive forces and give full play to the development enthusiasm of the whole society in order to allow the vitality of labor, knowledge, technology, managerial expertise and capital to compete in functioning and all sources of social wealth to be fully tapped.”14 Secondly, China’s state-society relation is interdependent and cooperative rather than confrontational and isolated. This feature is particularly reflected in the relationship between the governmental organizations and social organizations, that is to say, the social organizations and the government, maintain a good, cooperative relation. Such a cooperative relation is a major feature of China’s societal development and is also an essential element for a modern state to maintain stable growth. If the two forces confront each other in the direction of national development and lack consensus and cooperation, it is very likely to interrupt frequently the modernization process.15

Renaissance, the political system in modern western countries has been rather successful in inspiring public wisdom. However, the release of people’s desire, like Pandora’s Box, disturbed the existing political and economic order from time to time. And so far it’s still difficult to find an effective means to properly guide such desire. Therefore, the design of any political system should consider both the release of public wisdom and the restraint of excessive public desire. 14 Hu Jintao 胡锦涛, “Zai ji nian gaigekaifang 30 zhounian dahui jianghua 在纪念 改革开放 30 周年大会讲话 [Speech at assembly to commemorate the 30th anniversary of reform and opening up],” http://www.chinadaily.com.cn/hqzg/2008-12/18/ content_7318929_3.htm. 15 I do not agree with the views of some social and political science scholars, who believe that China’s NGOs are not real NGOs, but governmental organizations, in that they are not neutral and independent. In fact, the independence of the civil society (the NGOs) and its ability to restrain the state power and promote political democratization still remain as a myth. As a matter of fact, any powerful state always builds itself on a strong social basis. It’s difficult to imagine that a state confronts with the society instead of cooperating with it, and if so the state would like a tower building on sands. For example, in Western democratic countries, since the emerging class gained the state power, the state and the civil society began tacit cooperation right away. In modern times, due to the existence of the “revolving door” politics, the civil society appears to be independent. Yet no matter how independent these non-governmental organizations are, they would not go against their national loyalty. Otherwise, as a nonconformist force, the living space of these NGOs would gradually shrink.

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The core areas of human civilizations all once established certain geopolitical orders that organized around certain core concepts and systems. Those core concepts of each civilization area were roughly formed during the Axial Age and later became the intellectual capital for regional order after repeated reforms and transformations. In modern times, the character of the Western world order has developed over two phases.16 The first phase featured a laissez-faire model, and the second phase advocated a regulation model of the world order, politically and economically. The laissez-faire model separates the domestic political order from the international one and uses different principles to guide them. The domestic politics is hierarchically subject to the state authority while the international politics is automatically adjusted by the balance of power. The regulation model combined the domestic and international orders. Given that the laissez-faire model cannot guarantee peace and then international crisis often brings about devastating effects on the domestic order, in order to establish order in the international community, regulation must be exercised.17 As for how to achieve an ideal world order, Western philosophers such as Kant and Rawls, and politicians such as Wilson and Roosevelt advocated applying Western domestic systems to world politics, and they used the principle of their domestic order, namely the Western order, to transform world politics. In current international relations textbooks, this system is widely viewed as a liberal world order. There is a misleading idea in the epistemology of the Western order that views the world in the spirit of “One” (unity) rather than “More” (diversity). This expansionary epistemology partly came from religion. In practice, it guides the Western world to transform the diversified world and force the world to suit its own model. The order of the Western world was established after repeated wars. The expansion of the Western order reached its peak in the 20th century, especially during the period before and after the end of the Cold War. A significant problem that we need 16 Xu Zhuoyun 许倬云, Zhongguo gudai wenhua de tezhi 中国古代文化的特质 [The Characteristics of Ancient Chinese Culture] (Beijing: New Star Press, 2006), 113–141. 17 On the laissez-faire model and regulation model, see Su Changhe 苏长和, “Ziyou zhuyi yu shijie zhegnzhi 自由主义与世界政治 [Liberalism and World Politics],” World Economics and Politics, 4 (2004), 16–21. Su Changhe 苏长和, “Heyue, guojia lilun yu shijie zhixu 合约、国家理论与世界 秩序 [Domestic-International Mutual Transformation of Politics and Economy—On the Relationship between Domestic Change and International System],” World Economy and Politics, 11 (2007).



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to face in the future is how to deal with the complicated consequences that the declining Western order may bring to world politics. My point is the direct opposite of Fukuyama’s The End of History,18 that is, the expansion of the Western order has already reached its peak during the period before and after the end of the Cold War. This judgment is based on the following logic. First of all, the Western domestic order was established on a centerperiphery structure of the world politics and economy. This order is similar to the ancient Greek polis-colony model. The ancient Greek model of order, on the one hand, established a brilliant democratic system yet, on the other hand, coexisted with slavery and colony. Without the existence of slavery and colony, the democracy of the Cleisthenes’ era would lack its material foundation. In a similar way, the domestic order of the modern Western countries relies on the unequal international political and economic arrangements, and the complex distribution mechanism of international interests maintains their domestic prosperity and stability, for example, the unfair division of labor and international financial system. However, such center-periphery structure was first reshaped by the political independence of those peripheral countries in the beginning of the 20th century and then was shaken by the economic growth of those newly independent nation states in the 1970s and especially after the end of the Cold War. Most of these countries are members of the current G20 Summit. The economic development in those peripheral countries will relatively weaken the material foundation of the Western democracy and welfare systems. Second, history tells us that desire is destructive to human order. The Western domestic order still fails to manage released human desire and such expansionary human desire increases its dependence on resources in peripheral areas. This kind of dependence, however, won’t be everlasting. At the beginning of the Renaissance and the commercial tide of capitalism (also known as the liberation of humanity), there was a major shift in Western political ethics. It adopted the method of “using interest to tame desire” or “using desire to balance desire.”19 Such a method penetrated the systematic design of capitalism. As for the reconstruction 18 See Yoshihiro Fukuyama, The End of History and the Last Man, (New York: The ­Penguin Books, 1992). 19 This point is widely elaborated in Albert Hirchman 艾伯特·赫希曼, Yuwang yu liyi:ziben zhuyi zouxiang shengli qian de zhengzhi zhenglun 欲望与利益: 资本主义走向 胜利前的政治争论 [The Passions and the Interests: Political Arguments for Capitalism Before Its Triumph] (Shanghai: Shanghai Translation Publishing House, 2003).

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of its value system, it has replaced the concept of “desire” with the concept of “freedom.” Admittedly, the modern Western world experienced and contributed to a boom of public wisdom. Yet such public wisdom, motivated by the desire and passion in capitalism, explored more of the material world than of the relationship between humans and society and their inner order. If the “public desire” focused too much on the competition for exclusive resources, when such resource-dependence is interrupted or technological progress stagnated, the social order built on such interests would inevitably collapse. Third, the Western order is built on the basis of a strong military power. Such a strong military power renders military threat rather than diplomatic method as the most important way of settling disputes among Western countries and the disputes between the Western and non-Western world. In a mature capitalist democratic system, the power of the army is on the surface independent of party politics and military interventions in political affairs, which frequently appear in many developing countries. However, an essential feature of the political and economic system of capitalism is the alliance of military and business. Such an alliance enables the capitalist countries to frequently use military force to protect their narrow commercial interests. Although the power of the army is on the surface independent of partisan politics, yet different political parties reach a strong consensus on the role that the army plays in maintaining overseas commercial interests when it wins the election. It can be imagined that if there were no threats of violence backed by military power, it’s questionable how far Western freedom, democracy, commerce, and trade would have reached. If communication totally depended on cultural influence rather than military power, the Western order would still be limited to Femand Braudel’s Mediterranean world. Fourth, the Western modern democratic system, which developed from hundreds of years of political practice, has created a stable domestic order. However, due to the separation of domestic politics and international politics, the democratic mechanism becomes less effective when it’s applied internationally. From a large number of regular examples (not individual, isolated instances), it can be found that when democratic countries deal with the international community, they often become non-democratic or even coercive authoritarian, for example in cases of military interventions and the new interventionism actions in Kosovo, Libya, and Iraq. Many factors contribute to this phenomenon: (1) for example, the public seldom perceives the extraterritorial negative effect of the government’s public



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policy; (2) the public opinion has difficulty in influencing a country’s foreign policy on national security; (3) public welfare’s dependence on peripheral countries allows the public’s support for interference in other countries; (4) the system allows one country to transfer its domestic pressure to the outside world so as to protect its domestic welfare. According to this logic, the simple accumulation of democratic countries does not necessarily guarantee an international community of perpetual peace.20 As long as the negativity and self-interest of a country’s domestic politics are strong enough, its domestic democracy cannot guarantee it will always carry out cooperative policies in international politics. In this sense, the Western order is extremely exclusionary. IV. The China Model and the World Order The China model (China’s domestic and international development experience) demonstrates the Chinese people’s concept of its domestic order and the world order. This doesn’t mean that the Chinese people will without doubt actively spread the China model to the construction of the world order, and neither does it mean that the China model surely is universally applicable. Yet as a part of the human political civilization, the China model can provide certain enlightenment for some regions or countries, just like the fact that China draws on the experience of other advanced political civilizations during its development. The significance of the China model to the world order lies in three aspects. First, the core concept that sums up the spirit of how China conducts its political, economic and social life is cooperation, which is the very opposite of the checks and balances system in Western politics. The spirit of cooperation in current China’s political, economic, and social systems manifested in specific fields, including multi-party cooperation led by the Communist Party, political consultation, the combination of legislative and executive powers, a united front, the coexistence of diverse forms of ownership, and the mutual assistance between the state and society.21 These systems are the joint product of Marxism, China’s history, and its 20 Su Changhe 苏长和, “Bo mingzhu heping lun 驳 “民主和平论 [Refutation on Democratic Peace Theory],” European Research, 2 (1996), 27–31. 21  Lin Shangli 林尚立, Dangdai zhongguo zhegnzhi xingtai yanjiu 当代中国政治形态 研究 [The Study of Contemporary Chinese Political Formation] (Tianjin: Tianjin People’s Publishing House, 2000), 116–257.

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contemporary practices. For a country still modernizing, the spirit of cooperation embedded in these systems contributes to the formation of a relatively common consensus on its direction. Thus, the modernization process wouldn’t be frequently interrupted simply because of the divergence in understanding. The politics emphasizing cooperation considers its influences on political development from the overall interests of the state to all of the human population. Whereas the politics stressing checks and balances presumes that there are tensions between man and man, man and society, and man and nature. Such different leading spirits in political systems are partly due to different views about human nature. Western politics mostly regards human nature as evil, while China’s political philosophy mostly con‑ siders human nature as virtuous. For that reason, the Western systems emphasize checks and balances of different powers, using evil force to restrain evil force. Without such a presumption of evil human nature, its political systems would lack an operational basis. On the contrary, since ancient times, China’s politics has always stressed the significance of enlightenment on the change of human nature, including the cultivation of propriety, virtue, and reason. Thus, China’s systems, influenced by Confucius philosophy, highlight reconciliation and cooperation in political life. The divergences in these systems are also because China’s view on “differences” differs from that of the Western world. Western politics, influenced by its religious spirit, sees the world as divided in which there is a confrontation between “me” and “the other.” Therefore, whether in theory or practice, the “me” always has a strong inclination to change “the other.” In contrast, China’s social and political order respects divergences, advocating seeking common ground in differences while encouraging diversity. Therefore, China has formed a cooperative and a pluralist view on the world order. From the perspective of culture, Chinese culture ­features the principle of cultural federalism or diversity in unity. And during the cultural interaction between Central China and the other minorities, this kind of order spread and expanded rapidly. Such an order is entirely different from the Western order that has weathered repeated wars. The principle of cooperation needs to be integrated into the reform and the construction of international systems. Since the end of World War II, embedded liberalism, which advocates transforming the diversified world into one unified domestic order, guided the design of the international system rather than seeking one order through the reconciliation of different orders. This order opposes the cultural and political differences between countries and ideally expects that a universal culture or political



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system could be arranged to rule the world. In order to reflect the diversified reality and achieve the purpose of building a harmonious world, the reform of the international system needs to include the following key points: (1) expanding the representatives that can reflect the diversity of civilizations and seeking consensus on agendas through negotiations among different groups; (2) reducing the transnational economic interest groups’ dominance in setting the agenda; (3) cultivating the notion of mutual cooperation between domestic politics and international politics; (4) reducing the negative extraterritorial effects of domestic public policy; (5) expanding and enhancing the channels for dialogue. Second, the China model embodies cooperative political ethics. Just as Professor Shi Yinhong (时殷弘) mentions,22 President Hu Jintao’s speech at Yale University, which summarized the four major characteristics of Chinese civilization, is actually “a rising power’s historical declaration on what a morally decent world should be like.” Those four characteristics are the following: (1) The civilization always gives prominence to the people and respect for people’s dignity and values; (2) the civilization always gives prominence to unremitting self-improvement, reform and innovation; (3) the civilization always gives prominence to social harmony, unity, and mutual assistance; and (4) the civilization always gives prominence to good neighborliness. Cooperative political ethics differ essentially from Western ethics in that the cooperative political ethics consider an individual’s rights in the background of the whole social order from the very beginning, rather than regarding personal interests as the starting point of building social order. An ethical perspective may contribute to understanding such a difference. I think the evaluation of the moral level of individuals in the community or countries in the international community probably have several criteria. The best criterion is benefiting others while benefiting oneself, specifically, fairness, mutual benefit, and a win-win result. The second is benefiting oneself without harming others. Alain Peyrefitte in the late 18th century once wrote: “A person has every right to do things that benefit him so long as it doesn’t trample on the interests of

22 Shi Yinhong 时殷弘, “Chuantong neiwai de dangdai zhongguo: zhengzhilingdao, duiwai zhengce yu zhongguo tezheng 传统内外的当代中国: 政治领导、对外政策与 其中国特性 [Traditions in Both the Inside and Outside of Contemporary China: Political Leadership, Foreign Policies and Chinese Characteristics],” Foreign Affairs Review, 3 (2009): 7.

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others.”23 Yet this kind of ethic simply ignores the fact that an individual’s pursuit of personal interest may do harm to the social order. Adam Smith’s classical liberal economics did not expect this paradox that individual rationality often induces collective non-rationality on the whole. The third criterion is benefiting oneself at the expense of others’ interests. The worst criterion is preventing others from benefiting what one fails to enjoy like the dog in the manger. Trade protectionism falls exactly into this category. The cooperative view on political ethics considers society as a whole, and follows the principle of “benefiting others while benefiting oneself.” Thus, when Chinese people speak of personal freedom and human rights, they first of all put them in the context of the whole community. The idea that “a person has every right to do things that benefit him so long as they don’t hurt the interests of other people” doesn’t represent the whole picture of freedom for the Chinese. What’s more, under the backdrop of the “veil of ignorance” or behavioral effects that transcend time and space, how can a person or a country make sure that behavior, while benefiting him/her or it, won’t hurt the interests of others? The highest state of freedom is not to go beyond the rules of the whole community. The exercise of personal rights or the pursuit of personal desires should also follow this principle. Simply put, once a personal desire or personal action harms the order of the whole community, the legitimacy of the personal rights will lack an ethical and legal basis. Third, the China model can provide certain solutions to the modern world. What is the inner tension in today’s world political order? In short, it’s the tension between the modernization agenda and the postmodern agenda. Eighty percent of modern countries and their people face the development agenda, such as political order, economic growth, border disputes and conflicts, poverty, education, public health, organized crime, and environmental protection. The remaining 20 percent of countries that have already stepped into the welfare society are confronted with postmodern problems, for example, the tension between endless desire and limited resources/science technology, the increasing competition for resources, and the imbalance between formidable military power and threats of non-traditional security.24 Therefore, both the modern world 23 Alain Peyrefitte, Tingzhi de diguo: liangge shijie de zhuangji 停滞的帝国: 两个世 界的撞击 [The Immobile Empire—The Collision of Two Civilizations] (Beijing: SDX Joint Publishing Company, 1993), 1. 24 “The UN Report says 20% people in the world own 80% world wealth,” see http:// www.china.com.cn/aboutchina/txt/2009-09/07/content_18477153.htm.



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and the postmodern world confront hard political choices. The Western model’s influence on the non-Western world can be seen almost everywhere during the past 500 years. But the effect of such an order and system is not even counted as the second-best. Rare successful instances of Western order governing the non-Western world are concentrated in those countries with low social complexity. Yet for political bodies with large geographical areas, for example those that have their own complicated and unique civilization, history, and system, the Western experience was not so successful in pushing their political and social transformation even in Russia during the period immediately following the end of the Cold War. In other words, the Western model has quite a few successful examples in small non-Western countries, yet the one-way simple implementation of the Western model in large non-Western political bodies is not useful for maintaining the local social order.25 From the perspective of the modernization agenda and the postmodern agenda, the China model can provide one of the alternative models for countries still undergoing a modernization process. And the spirit of cooperation embedded in the China model can also enrich Western domestic order. This doesn’t mean that the China model is universally applicable, and it still needs to absorb the positive experiences of the Western model. For example, it should learn how the Western model inspired the people’s wisdom, which played a positive role in the development

25 A number of domestic and overseas Chinese scholars, especially economists, have a false presumption when they explore the solution of problems in China’s development process, that is, they assume that the Western liberal democracy can solve all the problems in China’s social development. Some of these views are listed below: Countries with abundant state treasury tend to have dim development prospects, while governments that borrow money often have more incentive to innovate. The modern finance requires freedom of the press since freedom of the press can provide the necessary transparent information for the financial market. The reason that the Chinese companies’ foreign acquisitions do not go well is that these companies are mostly state-owned, and if they were private enterprises, there would not be legal barriers. China’s trade friction is the result of a market economy that is not full, and if it were, the friction would lessen. China’s corruption problem results from the one-party politics, if multi-party competition existed, it would solve the problem of corruption. The tension between Chinese officials and the public is due to the lack of complete election, if election politics prevails, officials would be responsible for their voters, and thus improve their tense relations. The Chinese government is too rich while its people are too poor, and a small-government-and-big-society mode would be better. When per capita GDP reached $ 3000–5000, the process of democratization would turn on and the political reform required. The state-owned enterprises have inefficient governance performance, if they were privatized, managers would have incentives to improve their efficiency. Only if there were truly independent NGOs, the social power can be fully tapped.

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of human political civilization. Yet at the same time, it should be always vigilant about people’s desires that are released along with their wisdom. What’s more, even if the prediction about the decline of the Western order is true, it shouldn’t be overoptimistic to assume that the China model can fill the gap that the Western order leaves. Furthermore, China should always bear in mind that it still lacks certain knowledge in dealing with the outside world. The citizens’ international education is still far from enough to help them meet the qualities of international citizens. More negatively speaking, China’s reform and opening up during the past over 30 years also brought about the expansion of people’s desire especially shown in the field of commerce and business culture. China is still facing many problems, including corruption, and the increasing gap between the rich and the poor. Those problems remain a big challenge for China’s development. V. Conclusion At least in the foreseeable future, it seems that no single model can solely dominate the construction of the world order. And the political wisdom of humans has yet to develop to the degree necessary to establish a whole new political order that can cope with such a diversified, different, and complex real world. But the certain thing is that the China model is undoubtedly providing a new model and new possibility for regionalism in the practice of large-scale geopolitics, just as it contributed to regional order in the past. There are some questions that this paper fails to answer. Patience and faith are equally important in exploring China’s contribution to the world order. From the perspective of the integration of domestic and international politics, there are probably three possibilities for whether a model can transform into an agenda for world order: The first possibility is that the domestic model is actively promoted in world politics. This is similar to the Western practice. The second possibility is that domestic politics fails to cooperate with international politics. This model has to be limited to the domestic sphere. The third possibility is that such a model is the product of high-quality cooperation between domestic and international politics. Thus, it would be easier to carry out such a model in large-scale geographical politics and in the construction of the world political order. If we compare those three possibilities, we may make a breakthrough in further exploring the relationship between the China model and the world order.

CHAPTER SIX

TPP: A Major Challenge to China in the Process of Its Rise Li Xiangyang* Abstract: Trans-Pacific Partnership (TPP), employing both economic and political motives, constitutes an important component of the “return to Asia-Pacific” strategy of the United States. Containing China’s rise remains one of TPP’s undeniable objectives. The 2011 summit of the Asia-Pacific Economic Cooperation (APEC) members symbolized a stage of substantive talks TPP has entered. The stances of Japan and other East Asian nations will decide the TPP’s development prospects to a large extent. The Free Trade Area of Asia-Pacific (FTAAP) advocated by the US is basically a symbol without any practical significance during the current stage. Once TPP becomes a reality, APEC will possibly become the first organization to be sidelined in this region. For China, its exclusion from TPP not only means that it will be under the impact of “excludability effects” but it also means that the process of regional economic integration it has made unremitting efforts to advance in East Asia is likely to be reversed, a trend that will pose a major challenge to China in the process of its rise. Keywords: “Return to Asia-Pacific” strategy, TPP, Asia-Pacific Economic Cooperation (APEC), East Asian regional economic integration

The Trans-Pacific Partnership (TPP) has already attracted extensive attention although formal negotiations regarding it are still underway. The reason for this attention is that its formation and future actions will influence the configuration of economic cooperation in a region that possesses the most energetic economy in the world. More importantly, behind TPP is a game playing among larger countries, especially a possible re-­organization of trilateral ties between the United States, Japan, and China. There is a very slim possibility for China’s entry into TPP, but the formation of the US-spearheaded partnership will constitute a major challenge to the country’s peaceful rise. * The Chinese version of this article was first carried in Guoji jingji pinglun 国际经 济评 [International Economic Review], (2) 2012. Li Xiangyang is President of the Institute of Asia-Pacific and Global Strategy at Chinese Academy of Social Sciences. His email address is [email protected].

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li xiangyang I. TPP and the “Return to Asia-Pacific” Strategy of the United States

The return to Asia-Pacific strategy remains the core part of global strategic adjustments the United States pushed over the past years. The strategy is based on two concepts with one is security diplomacy and the other economic cooperation. In 2011, the United States marked to push its return to Asia-Pacific into a substantive stage. In the domain of security diplomacy, the United States attended the first East Asian Summit with Russia. At the same time, it strengthened bilateral relationships with countries that enjoy military alliances with Washington. In the field of economic cooperation, the United States, taking advantage of the APEC summit it sponsored in November 2011, formally presented to relevant countries the framework agreement of TPP. As the advocate of TPP, the United States has conferred two basic objectives on the agreement from the very beginning.1 The first one, according to the United States, is an open regionalism. It means that TPP is open to all 21 APEC members. In other words, all APEC members can freely join TPP if they are qualified for its membership thresholds. Its final goal is to set up a free trade area in the Asia-Pacific region that covers all APEC members. The second objective is to sign a free trade area agreement aimed at promoting high-quality trade in the 21st century. The term “high quality” means reducing tariffs and realizing trade and investment liberalization, the making of unified rules on intellectual property rights (IPR) protection, environmental protection, and unified competition policies labor standards. As a matter of fact, the United States transplanted North American Free Trade Agreement (NAFTA) rules to the planned TPP.2 A review of the two objectives of TPP will find that the “high-quality free trade agreement” will set an insurmountable entry threshold for many countries, and the “open regionalism” advocated by Washington is thus be used only as a guise. What are the motives for the United States to advocate the establishment of TPP? Answers to this question are related to what conclusions can be drawn on TPP’s nature, its development prospects, and more

1  TPP was originally a free trade area agreement signed by Singapore, Brunei, New Zealand and Chile. However, the US’ entry has changed its original nature and the stonger member has dominated the talks on its rules ever since. 2 Jagdish N. Bhagwati, “America’s Threat to Trans-Pacific Trade,” East Asia Forum, January 10th, 2012.



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importantly its possible influences on China. There are different opinions on this issue in the domestic academic circle, which can be summarized by the following viewpoints. First, the United States released an official statement about sharing the benefit of the high-speed economic growth in Asia.3 From the start of the 21st century, high-speed economic growth in Asia has caught the attention of the rest of the world. The Asian economy has also already become the locomotive of global economic growth, especially since the eruption of the international financial crisis in 2008. It is precisely because of this that many people have branded the 21st century as the “Pacific Century.” Second, the United States wants to create favorable conditions for the Obama administration’s strategy for doubling exports. In the wake of the global financial crisis, the Obama administration put forward an ambitious target to double US exports within five years from 2009.4 The third motivation is to help to re-organize the United States’ resource map in rebuilding its credit system.5 Given that the survival rights of a country and its survival space are based on its resources, the resource map, including its land resources, is regarded as a lifeline by any nation. For a nation, building a survival space, a space that regards the control of resources as its core and goes beyond the traditional concept of sovereign territory, will constitute its “resource map.” The fundamental strategic target for the United States to actively push forward TPP is to maintain and expand its “resource map” in its efforts to extricate itself from the global financial crisis. To attain this goal, what the United States should do, in Washington’s eyes, is reconstruct its collapsed credit system in the post-crisis era in a bid to attain the target of re-partitioning the world’s resources and wealth, and continue maintaining its hegemonic status as a superpower. Fourth, the United States wants to offset discrimination against US exports from an Asian bloc. The United States will not 3 Liu Zhongwei and Shen Jiawen 刘中伟、沈加文, “kua taipingyang huoban guanxi xieyi: yanjiu qianyan yu jiagou 跨太平洋伙伴关系协议：研究前沿与架构 [The TransPacific Partnership Agreement: the Research Forefront and Framework],” Contemporary Asia-Pacific Studies 1 (2012): 35–59. 4 Shiro Armstrong, “TPP Needs Less Haste, More Caution,” East Asia Forum, April 17th, 2011. Another explanation relevant to this is after the WTO Doha Round has come to a standstill, the trade and investment liberalization pushed by APEC members cannot satisfy the demands of the US, which has thus prompted Washington to open a new trade front. Such an explanation sounds partially reasonable. The US also opened talks on the NAFTA when the WTO Uruguay Round came to a standstill, which objectively played a certain role in helping finally finish the Uruguay Round. 5 Zhang Jie 张捷, “meiguo yu chonggou ziyuan bantu yu xinyong tixi 美国欲重构资 源版图与信用体系 [The US Is Intended to Reconstruct its Resource Map and Credit System],” 环球财经 huanqiu caijing [Business World], Jan. 13, 2012: 33–45.

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allow the drawing of “a line down the Pacific,” as former US Secretary of State James Baker puts it.6 Fifth, the United States wants to contain the rise of China,7 a motive the United States never officially admitted. Washington’s above-mentioned motives show that the first standpoint, to share the benefit of high-speech economic growth in Asia, is objectively reasonable given that it is based on an internationally recognized consensus. The second standpoint, to create favorable conditions for the Obama administration’s strategy for doubling exports, does not sound strong. The reason is that the United States’ strategy for doubling exports only has a time span from 2009 to 2014, while TPP talks are planned to be completed in 2015. The third standpoint, to help re-organize the United States’ resource map to rebuild its credit system, also covers a wider region. Under such logic, the United States should also have included Europe, the Middle East, and Africa in its free trade areas through signing relevant free trade area agreements. The fourth standpoint, to prevent the United States being excluded from East Asian regional economic integration, enjoys a certain degree of credibility. Over the past decade, a majority of economic cooperation programs worked out by East Asian countries, such as the framework of the 10+3 and 10+6 frameworks as well as the East Asian Community, all failed to cover the United States. In fact since the 1980s, the United States has been opposed to the establishment of regional economic integration programs in Asia exclusive of the United States, such as the Asian Monetary Fund put forward by Japan in the wake of the Asian financial crisis. However, if Washington only builds its TPP plan on the defensive, then its preferred option will be to join the current East Asian regional economic cooperation framework rather than try to set up a new cooperation mechanism. The fifth standpoint, to contain the rise of China, is one that has caused much controversy. Opponents claim that the US government has not recognized such a motive, and thus it has the risk of being regarded as a conspiracy theory. Proponents, however, hold that there are inherent ideological discrepancies between China and

6 C. Fred Bergsten and Jeffrey J. Schott, Speeches and Papers Submission to the USTR in Support of a Trans-Pacific Partnership Agreement, Peterson Institute for International Economics, January 25, 2010. 7 Peter Drysdale, “China, Economic Containment and the TPP,” East Asia Forum, December 12th, 2011. C. Fred Bergsten and Jeffrey J. Schott, Speeches and Papers Submission to the USTR in Support of a Trans-Pacific Partnership Agreement, Peterson Institute for International Economics, January 25, 2010.



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the United States; thus it is natural for Washington to extend its conceptualized TPP close to China’s door as a way to contain its rise. Debates involving whether the United States is to contain China mainly focus on whether there exist fundamental interest disputes between the two powers and, if there are, exactly what they are. We believe that some ideological differences do exist between China and the United States, but the main problem between Beijing and Washington is how a rapidly rising power and an old hegemonic power deal with each other. For the United States, it is only a matter of time before China’s GDP exceeds America. What Washington is most concerned about is the challenge China will pose to the United States’ established hegemony after its rise. In the era of nuclear weapons, the possibility of war between two big powers becomes decreases and competition between them has increasingly focused on struggles for dominance over international rule making. The United States, and Europe to some extent, serve as the makers of current international rules. As a result they are the rules’ largest beneficiaries. Therefore, the core of the United States’ strategy for China remains focused on how to ensure that China will not challenge prevailing international rules when its economic size surpasses the United States’. Over the past 10 years, regional economic cooperation in East Asia achieved remarkable progress, with the “10+1” mechanism, a free trade agreement between ASEAN and China, already taking shape. The 10+3 model, a free trade area between the 10-member ASEAN and China, Japan, and South Korea, or the 10+6 model, a free trade agreement between ASEAN and China, Japan, South Korea, India, Australia, and New Zealand is expected to dominate the future direction for regional economic cooperation. In light of the fact that China surpassed Japan to become the largest economy in Asia, it is the largest trading partner and the largest exporting market to a majority of Asian nations, and especially the fact China’s fastgrowing economy has become a main driver of Asian economic growth following the global financial crisis,8 East Asian integration with China as the economic core is an emerging pattern.9 This is an outcome that the 8 Donghyun Park and Kwanho Shin, “Can Trade with the People’s Republic of China be an Engine of Growth for Developing Asia?”ADB Economics Working Paper Series 172 (2009): 1, URL: http://www.adb.org/publications/can-trade-peoples-republic-china-be -engine-growth-developing-asia. 9 For many years, the ASEAN has been regarded as the driver of regional economic cooperation in East Asia, a result of many years of competitions among regional powers such as China, Japan and South Korea. Although China has always made it clear that it backs the leading role of the ASEAN in East Asian economic cooperation, there has

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United States cannot tolerate because Washington will lose or partly lose its dominant power over the international rule making in a region that is the most economically energetic in the world. If we accept the “China containment” theory, then the United States would plan to exclude China from TPP from the very beginning, a move that is in contravention of its highly advocated openness principle. The history of regional economic cooperation shows that setting up a regional trade agreement is by no means the pursuit of economic goals alone.10 In this sense, there exist vast differences between a regional trade agreement and a multilateral trade agreement. Some people claim that China should look at TPP with the same attitude it held toward its WTO entry—on the grounds that a decade of China’s WTO membership indicates that its admission to the world body pushed forward reforms of its economic institutions and helped integrate China into the world economy faster. Although there are still difficulties for it to accept TPP rules at the current stage, China, it is believed, can still use the event as an opportunity to push for reforms of its economic and political institutions. China should not remain aloof from TPP just because it is a US-spearheaded ­arrangement.11 Such an argument not only confuses the differences between a regional trade agreement and a multilateral trade agreement but also turns a blind eye to the fundamental interest disputes between China and the United States.12

been growing doubts in the international community about ASEAN’s role as “a little house drives a big wagon.” Following the rise of China’s economy, an East Asian economic cooperation with China as the core now remains a general trend. 10 Li Xiangyang 李向阳, “xinyuyu zhuyi yu daguo zhanlue 新区域主义与大国战略 [New Regionalism and the Power Strategy],” International Economic Review 3 (2003). 11  Lin Qianya 林倩娅, “The ‘conspiracy theory’ of TPP is incredible,” TPP 阴谋论不足信, 2011 年11月14日, http://opinion.caixin.com/2011-11-14/100326161.html. Editorial of new century《新世纪》周刊社评: “To deal with TPP in the same attitude China held toward its WTO membership,” 以对 WTO 的态度对 TPP, 2011 年第45期, http://magazine.caixin.com/2011-11-18/100329192.html. 12 An interview of Australian Broadcasting Corporation with Obama in April 2010 will help us better understand the interest disputes between China and the US on international rules and orders. In this interview, Obama said “if over a billion Chinese citizens have the same living patterns as Australians and Americans do right now then all of us are in for a very miserable time, the planet just can’t sustain it, so they understand that they’ve got to make a decision about a new model that is more sustainable that allows them to pursue the economic growth that they’re pursuing while at the same time dealing with these environmental consequences.” http://www.abc.net.au/7.30/content/2010/ s2872726.htm.



tpp: a major challenge to china in the process of its rise 93 II. Stances Held by Japan and Other East Asian Nations Toward TPP

From the perspective of the first batch of countries chosen by the United States, TPP will have negligible economic effects on the United States, given that its eight other members only account for 4 percent of global economic size and four of them—Chile, Peru, Singapore, and Australia— have already signed bilateral free trade agreements with the United States. However, TPP would become a regional trade agreement that is of great significance once Japan joins. In terms of their economic shares in TPP following Japan’s entry, the United States will account for 67 percent, Japan 24 percent, and the other eight members a combined 9 percent. If Japan’s entry can result in the opening of its domestic market, especially Japan’s agricultural and services markets, then other TPP members are expected to gain huge economic effects. In 2010, the trade volume between the United States and other TPP members was $170.9 billion, only 5.3 percent of the United States’ total import and export value. None of them was among Washington’s 10 largest exporting markets. However, Japan’s entry will boost to 351.8 billion US dollars the United States trade with other TPP members, or 11 percent of Washington’s trade value.13 The announcement made by the Japanese Yoshihiko Noda government ahead of the APEC Hawaii summit that Japan will join TPP talks marked a significant event for TPP.14 Such a decision was also a display of Japan’s foreign policies, symbolizing Tokyo’s shift from backing the Asialed regional economic cooperation strategy—as indicated by the “Asian Monetary Fund” it advocated in the 1990s following the Asian financial crisis, the 10+6 program, and the “East Asian Community” conceptualized by the Yukio Hatoyama government—to backing the regional economic cooperation strategy dominated by the US-Japan alliance, as indicated by the Japanese Noda government stance toward TPP. The shift of Japan’s regional economic cooperation strategy is a result of its domestic debates about national re-orientation in recent years. The national re-orientation has been Tokyo’s response to the rapid rise of China’s economy. This has made Japan increasingly worried over the losing of its No. 1 status in Asia. Such kinds of worries became a reality in 13 Peter Drysdale, “China, Economic Containment and the TPP,” 2011. 14 Along with Japan to join TPP talks are also Canada and Mexico. Because TPP’s basic rules have been made in reference to the NAFTA rules, the two countries have encountered almost no any hurdles for their entry into TPP.

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2010 when China surpassed Japan to become the largest Asian economy. Over the past 10 years, Japan showed a cold shoulder to the establishment of the China-Japan-South Korea free trade area. It also maintained a resistant attitude toward the 10+3 program. Instead, Japan forcibly advocates the 10+6 program. All these are an indication of Tokyo’s evergrowing ­concerns regarding China’s rise, and the question whether Japan or China will dominate the directions of Asian regional economic cooperation. Japan never officially admitted its competition with China to be a dominant regional power, but it remains an important factor obstructing smoother China-Japan cooperation.15 Following the international financial crisis, there were confirmed changes in Asia’s economic pattern. The change of the Asian economic pattern was verified following the international financial crisis, as indicated by the growing economic dependence of other Asian nations, including Japan, on China’s economy. In this context, Japan’s national re-orientation direction has gradually become clearer—that is, Tokyo should embrace a hedging strategy between the United States and China. It should share the benefits brought by high-speed economic growth in China and Asia as a whole, and at the same time try to strengthen the US-Japan alliance in the political domain and take advantage of Washington’s return to Asia-Pacific strategy to balance China’s ever-growing influence. As far as its specific regional economic cooperation strategy is concerned, Japan should not only join TPP but also should not abandon efforts to push for a free trade area with China and South Korea, although the TPP membership takes precedence. In fact, the Japanese Noda government has always held a negative attitude toward the foreign policies adopted by its predecessor, the Yukio Hatoyama government. The Noda government announced just after taking office that “our policies are not targeted at the establishment of the East Asian Community.” Japanese Foreign Minister Koichiro Gemba also believes that “we should not call the region exclusive of the United States as East Asia and instead call the region inclusive of the US as Asia-Pacific.” The two Japanese politicians repeatedly stressed this standpoint, claiming “for Japan, whether to adhere to democratic values in the Asia-Pacific region serve Japan’s ­significant 15 At a symposium on “transcending hurdles and advancing into the future”: The development prospect of the China-Japan-South Korean free trade, held in Beijing in October 2010, participating scholars from China, Japan and South Korea reached a basic consensus that the main hurdles facing the trilateral free trade not only come from economic factors but also more importantly come from some non-economic factors, among which is their contestation for a dominant power in the region.



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interest relevant to its rise or decline.”16 Upon Tokyo’s announcement of its plan to join TPP talks, some senior Japanese officials claimed that to enter TPP is to change the China-led Asian economic cooperation pattern into one in which the region’s future’s rules will be jointly decided by the United States and Japan. Compared with Japan, some smaller Asian nations are more motivated to adopt an edging strategy between the United States and China. They also hold an inclination to reduce their economic dependence on China. Of the nine countries that announced their entry into TPP, four are Asian nations—Vietnam, Malaysia, Singapore, and Brunei.17 Small Asian nations have generally held a welcoming attitude toward the United States’ return to Asia-Pacific strategy and TPP. At the economic front, these small nations have had a rising dependence on China’s market due to China’s high-speed economic growth and a strengthened international manufacturing network in East Asia. China is now the largest export market to a majority of these small Asian nations. Asian regional economic cooperation, with a few 10+1 mechanisms as the main body, has made substantive progresses over the past decade. In particular, the implementation of the China-ASEAN free trade area rapidly expanded the scale of two-way trade and investment, and increased the dependence of ASEAN countries on China. Based on their worries about China’s rise and considerations to diversify possible market risks, some ASEAN countries have regarded the entry into TPP as a new option beyond the 10+1 cooperation framework. The 10+3 mechanism has also become another direction for Asian regional economic cooperation for many years. However, a broader free trade agreement covering the whole region has not been established in the region because of ASEAN’s apathy over concerns about the possibility of being marginalized as well as the failure of China, Japan, and South

16 Kondo Daisuke 近藤大介, “riben de nanhai lichang 日本的南海立场 [ Japan’s Stance on the South China Sea],” 经济观察报 jingji guancha bao [The Economic Observer], Oct 24, 2011: 49. 17 Some other Southeast Asian nations have also shown their interest in the TPP membership. At the same time, the US is planning to employ the Trade and Investment Framework Agreement (TIFA) or other dialogue mechanisms established with these countries to help them make preparations for TPP entry. According to the Office of the United States Trade Representative (USTR), the US also reached a series of TIFA agreements with Cambodia, Indonesia, the Philippines and Thailand in addition to the TIFA agreement reached with the ASEAN as a whole. See The Possibility of Southeast Asian Nations Entering TPP and its Influences, http://www.sccwto.net/webpages/WebMessageAction_viewIndex1 .action?menuid=FDAAAD4B2B89483C92A4DEEAB4640CB3&id=53c24f19-209a-46b6827a-1e303e5b947d.

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Korea to reach a consensus. The absence of such a broad free trade area agreement created conditions for the birth of TPP. On the security front, East Asia has so far failed to establish a regional security regime, and thus left a security vacuum as the United States has put its anti-terrorism focus on West Asia and North Africa following the September 11, 2001 terrorist attacks.18 On the other hand, some regional countries, such as Vietnam and the Philippines, disagree with China over territorial disputes in the South China Sea, and some still enjoy traditional bilateral military alliances with the United States. Under these circumstances, the return to Asia-Pacific strategy of the United States not only caters to some Asian nations’ requirements for Washington’s intervention but also fills the security vacuum in the region. For Asian nations, such a hedging strategy—to not only benefit from China’s enormous market and its fast-growing economy but also to turn to the security shield offered by the United States and TPP—is obviously a choice to maximize their interests. Certainly, the success of the strategy should be based on the precondition that contradictions exist between China and the United States, but they will not escalate into head-on confrontations between the two countries. The lack of contradictions between Beijing and Washington will forfeit the precondition for its success. Likewise, a head-on confrontation between China and the United States will also prompt Asian nations to take sides. III. The Prospect of TPP and FTAAP One of the ideal goals for the United States’ efforts to promote the establishment of TPP is to finally establish the Free Trade Area of Asia-Pacific (FTAAP) that covers all APEC members. It is Washington’s logic that pushing for the realization of a mechanism for multilateral trade liberalization through regionalism remains an inevitable choice since the WTO Doha Round fails to push for its realization. According to Washington’s logic, TPP will serve as a stepping-stone to multilateralism instead of a 18 This is largely related with China’s “non-intervention” foreign policy and its strategy of “keeping a low profile.” As professor Yan Xuetong pointed out, if China cannot offer to surrounding nations security shields, then they will possibly turn to the US for such guarantees, which will add pressures to China’s strategic security. See “zhongguo keyu meiguo zhengduo youhao guojia 中国可与美国争夺友好国家 [China can strive for friendly countries with the US],” guoji xianqu daobao 国际先驱导报 International Herald Leader, May 27, 2011.



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stumbling block.19 It seems that the establishment of TPP will draw an ideal blueprint for multilateralism in the Asia-Pacific region, but its inherent nature determines that the FTAAP is difficult to come to reality in the foreseeable future. First, TPP by itself remains unable to eradicate the Spaghetti Bowl Effect within the framework of Asia-Pacific regional economic ­cooperation.20 The Spaghetti Bowl Effect is a phenomenon of international economic policy that refers to complications arising from the application of domestic rules of origin and other preferential measures to the members of multiple bilateral free trade areas at a time when a wider free trade agreement is signed among more regional members. The effect will lead to different and discriminatory trade policies because the same commodities are subjected to different tariffs and tariff cuts in relevant countries, which will offset and reduce the benefits brought by the liberalization of investment and trade within a broader free trade agreement framework. So far, the nine members of TPP signed about 25 free trade agreements among themselves. However, most of these agreements are usually detrimental to a third party. Take Australia for example, the United States’ sugar and milk are excluded from the Free Trade Agreement it signed with the United States.21 Theoretically, the established bilateral free trade agreements among some members should automatically become invalid after TPP takes effect so that unified TPP rules can be implemented among members. However, the United States was opposed to such a practice from the very beginning because Washington has so far signed with 17 regional countries on 11 free trade agreements, all of which, already effective, have contained specific articles to serve their specific purposes. Provided that TPP cannot eradicate the negative effects produced by overlapped free

19  There currently exist huge disputes among economists on whether regionalism serves as a springboard or a stumbling block to multilateralism. See Baldwin (2006) for more details: R. Baldwin, “Multilateralising Regionalism: Spaghetti Bowls as Building Blocs on the Path to Global Free Trade,” The World Economy 29 (2006): 1451–1518. 20 Peter A. Petri, Michael G. Plummer, and Fan Zhai, “Trans-Pacific Partnership and Asia-Pacific Integration: A Quantitative Assessment,” East-West Center Working Papers, Economics Series 119 (2011): 1. Shen Minghui 沈铭辉, “kua taipingyang huoban guanxi xieyi de chengben shouyi fenxi 跨太平洋伙伴关系协议的成本收益分析：中国的视角 [An Analysis on the Costs and Returns of the Trans-Pacific Partnership: China’s Perspective],” dangdai yatai 当代亚太 Contemporary Asia-Pacific Studies 1 (2012): 5. 21  Shiro Armstrong, “TPP Needs Less Haste, More Caution,” East Asia Forum April 17th, 2011. http://www.eastasiaforum.org/2011/04/17/tpp-needs-less-haste-more-caution/.

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trade agreements among members, it will unlikely become the groundwork of the future’s FTAAP. Theoretically, ways to ease or eradicate the Spaghetti Bowl Effect are as follows: (1) to strengthen a free trade agreement that covers the whole region; to unify Most-Favored-Nation Treatment Tariffs (MFN); (2) to create multilateral preferential measures; (3) to weaken the rules of origin.22 However, without support from the United States and its propulsion, there is not a possibility for all these measures to come true. Second, differentiated treatment rules are expected to be applied to TPP’s new members, which will make its open regionalism, a principle advocated by the United States, a mere symbol that it will be difficult to realize. The exceptional articles existing in bilateral free trade agreements will constitute hurdles for newcomers in the future. To gain TPP membership, newcomers either have to hold separate talks with every TPP member and acquire unanimous agreement from all members, a procedure that will enable certain countries to exercise their power of veto. As a way of resolving this dilemma, the TPP should lay down some definite and explicit regulations on the entry of new members to reduce the decisionmaking power of individual members as much as possible. However, the United States’ extant laws and system make it difficult for Washington to make concessions on this issue.23 According to US laws, the Congress is empowered to carry out checks, verification, and approval of the qualification of any TPP candidates. Third, discrepancies among APEC members decide that the United States’ main motives in pushing for TPP will be difficult to realize. APEC comprises both most developed and least developed economies. Within it there are not only ideological differences but also contention among big powers for a leading role. Despite its considerations for economic interests, the United States, in its efforts to push for TPP, mainly wants to gain an upper hand in the power-to-power game play in this region. Not considering the immense difficulties in coordinating relations among some small APEC members within APEC, carrying out effective coordination among some large powers in the region, such as the United States, 22 Shiro Armstrong, “Australia and the Future of the Trans-Pacific Partnership Agreement,” EABER Working Paper Series 71 (2011). http://papers.ssrn.com/sol3/papers.cfm? abstract_id=1970129. 23 Peter Drysdale, “Are there real dangers in the Trans Pacific Partnership Idea?,” East Asia Forum April 18th, 2011. http://www.eastasiaforum.org/2011/04/18/are-there-real­dangers-in-the-trans-pacific-partnership-idea/.



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China, Japan, and Russia, will remain a big challenge to the establishment of FTAAP. A review of the history will find that it is not the first time the United States disclosed its attempt to set up a free trade area dominated by it. In response to an announcement made by the European Community in 1986 to set up a bigger and unified European market with the European Free Trade Area (EFTA) and by 1992, the United States declared to start talks with Canada on the establishment of a US-Canada free trade area. In 1992, the European Union signed the law in the European Union, symbolizing the establishment of a broad united European market. At the same year, the US-Canada free trade area was also expanded into the NAFTA. In response to the eastward expansion of the European Union, the United States decided to start negotiations on the establishment of the Free Trade Area of the Americas (FTAA), in a bid to cover all countries in the Western Hemisphere except Cuba. After taking office, the George W. Bush administration further regarded the establishment of the FTAA as its top priority and gained approval from the US Congress. After taking office, Brazilian President Luiz Inacio Lula da Silva refused the United States’ program on the ground that Brazil cannot accept its labor standards, causing the abortion of the more substantive free trade area. Later, the United States chose to sign a free trade agreement (DR-CAFTA) with Dominica and other Central American countries such as Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua. A look at such a history indicates that the United States’ strategy to push for a free trade area has never been based on economic goals alone. Washington has neither regarded the establishment of a free trade area as a springboard to the realization of multilateral trade liberalization. So far, the regional economic cooperation strategy the United States adopted also cannot prove that it will utilize FTAAP as a stepping-stone, and then push for multilateral trade liberalization as the ultimate target of TPP. IV. TPP’s Influences on the Pattern of Asian Regional Economic Cooperation As part of its return to Asia-Pacific strategy, the United States’ efforts toward expanding TPP will change the landscape of East Asian economic cooperation and unavoidably influence the process of China’s rise. Given that FTAAP is still a nominal symbol, the APEC’s internal structure will display a dual-track character following the enforcement of TPP. Over the

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past 20 years, APEC has always been the largest regional economic cooperation organization in the Asia-Pacific region. More importantly, it has provided a platform for exchanges and communication among regional leaders to handle the region’s internal affairs. Once TPP becomes effective, APEC members will inevitably be divided into two camps, with some belonging to TPP and others not. Considering commitments made by APEC members lack a binding force, the influence of the organization on regional cooperation will decline in the future. Its attractiveness to nonTPP members will also decrease accordingly unless some want to take advantage of its platform to facilitate their entry into TPP. Second, Asian regional economic cooperation featured as the “10+X” mechanisms will possibly come to a standstill because of TPP. Over the past 10-plus years, the “10+1” cooperation model built by the region’s big powers has basically been established. However, the “10+3” and “10+6” cooperation mechanisms have failed to achieve substantive progresses because they are believed to be incompatible with ASEAN’s targets. Provided that Japan is admitted to TPP as one of the first batch of new members, Asia’s current regional economic cooperation will plunge into a standstill at least for the time being.24 From an American perspective, the United States is motivated to accept Japan as a member even if that will prolong TPP’s talks process and even lower its quality because huge political obstructions exist in Japan about its opening of agricultural, auto, and service sectors. Despite the existence of considerable uncertainties involving TPP talks, which were originally planned to be completed by the end of 2012, and the fact that it will not bring Asian countries tangible economic benefits within a short period, its advancement will still likely obstruct the ongoing development momentum of regional economic cooperation in Asia. The entry of Japan and some ASEAN members into TPP will surely reduce their demands on the “10+3” and “10+6” cooperation mechanisms, a result that the United States has been longing for. Third, ASEAN will lose its leadership role in East Asian regional economic cooperation. The special status ASEAN countries enjoyed in the region’s power struggles among large countries stems from their integration. However, once some ASEAN countries join TPP while others members do not, the dual-track character within the 10-member bloc will

24 According to estimates by some experts from Japan External Trade Organization (JETRO), Japan will strive to become a founding member of TPP to avoid the result that it, as a non-founding member, has to accept TPP’s rules laid down by its founding member.



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become more evident.25 It also remains unknown whether the target of building the ASEAN community, originally planned to be established by 2015, will be negatively affected. On the other hand, the changes expected to occur to the process of Asian economic cooperation dominated by the “10+X” cooperative mechanisms will cause ASEAN to lose its leadership status. Fourth, the hedging strategy embraced by some Asian nations lacks an internal stability. The United States’ return to Asia-Pacific strategy provided the possibility for some Asian nations to adopt the hedging strategy, but such a strategic choice based on Sino-US contradictions is not expected to sustain its continuing momentum. China’s determination to change its economic development model in the post-crisis era is beyond doubt, and its rapidly expanding market is irresistible to most countries. Following China’s peaceful rise, the space for Sino-US cooperation not only in the economic domain but also in the field of regional and even global security will become wider although uncertainties still remain involving their approach to cooperation. Once changes emerge in the form of SinoUS cooperation, the hedging strategy of some Asian nations will have to be changed. Fifth, there are still possibilities for the coexistence between the China-Japan-ROK free trade area and TPP. The attitudes Japan will hold will exert important influences on the trilateral free trade area and TPP’s future trend. There exist different assessment standards within Japan on the benefits to be brought about by TPP and the China-Japan-ROK free trade area, which have thus drawn confusing and conflicting conclusions. This is also a result in the broader context of Japan’s “national re-­orientation.” For example, Yonekura Hiroshima, chairman of Keidanren, Japan’s chamber of commerce, also crowned as the Prime Minister in the financial circle, believes that Japan will be reduced to the world’s orphan if it does not join TPP. Japan’s Cabinet Office, through calculations, claims that Japan’s gross domestic product will increase by from 2.4 trillion to 3.2 trillion Japanese yen within 10 years if it signs TPP. The Ministry of Economy, Trade, and Industry predicts that if it does not join TPP, Japan will suffer a loss of 10.5 trillion Japanese yen, and its number of unemployed will increase by 812,000 once the ROK signs an FTA agreement with the United States, China, or the European Union. More

25 Due to their different economic development levels, there always exists an “old ASEAN” and a “new ASEAN” within the bloc.

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important, it believes, TPP will become a de facto FTA between Japan and the United States, which will not only affect Japan’s future political and economic directions but will also influence East Asian regional integration and disrupt China’s East Asian strategy. Japan’s Ministry of Agriculture, Forestry and Fisheries, however, believes that TPP membership will bring to Japan a loss of 11.6 trillion Japanese yen within 10 years and cause about 3.4 million of its people to become unemployed. Despite the establishment of a free trade area, the degree of trade interdependence among China, Japan, and the ROK is currently only about 25 percent, far below 40 percent to 70 percent trade interdependence among NAFTA members. In particular, China’s trade dependence on Japan and the ROK declined to 16 percent in 2011 from 21 percent in 2005. However, the intra-regional trade in Northeast Asia still enjoys enormous potential. China and Japan especially share huge economic mutually complementing benefits and China’s ongoing industrial upgrading makes cooperation with neighboring Japan more necessary.26 Currently, Japan is making active efforts for TPP talks and is also making preparations for talks on the establishment of the China-Japan-ROK FTA and the Japan-EU FTA with the former taking precedence.27 In doing so, Japan’s purpose is to utilize ongoing talks with China and the ROK on a trilateral free trade area as a chip to pressure the United States into relaxing restrictions on its TPP membership. On the contrary, Japan will also raise more demands on China and the ROK on the establishment of the trilateral free trade area once it succeeds in joining TPP. Sixth, a TPP exclusive of China will possibly be detrimental to the smooth process of regional economic cooperation in Asia. Judging from the current TPP threshold and the United States’ unveiled motives, China is unlikely to be admitted within the foreseeable future. As a result, China will inevitably be under the impact of the excludability effect of TPP in economic and non-economic fields. As the largest economy in Asia and the most important engine of Asian economic growth, China 26 Cai Chenping 蔡成平, “riben jiaru TPP dui zhongguo de yingxiang 日本加入 TPP 对中国的影响 [Influences of Japan’s Entry into the Trans-Pacific Partnership on China],” Financial Times, Nov. 9, 2011. http://www.ftchinese.com/story/001041639. 27 Many Japanese scholars and officials stress that to first eradicate the hurdles of Japan’s agricultural protection through TPP talks will facilitate Japan’s talks with China and the ROK on the trilateral FTA in the next stage. It is a reasonable judgment that Japan’s regional economic cooperation strategy only takes into consideration economic factors. However, the conclusion would cause controversies that more non-economic factors have constituted Japan’s regional economic cooperation strategy.



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has remained an active promoter of Asia’s intra-regional economic cooperation. Facing the impact of the excludability effect, the type of regional economic cooperation strategy China will choose will play a critical role in deciding the development direction of Asian economic cooperation. Asian economic cooperation has always been a market-driven process instead of an institution-driven one. In other words, the foundation of Asian regional economic cooperation is the internal economic mutually beneficial complement among regional members, of which, the welldeveloped East Asian international manufacturing network has played the role of the bridge. It is now difficult to draw a conclusion whether a TPP exclusive of China will change the established foundation of Asian regional economic cooperation. If it does, the groundwork of Asian economic growth will weaken. If it does not, conflicts will emerge between a market-driven Asian regional economic cooperation with an institutionsdriven one, namely TPP. The assessment of TPP’s prospect and influence is still at the stage of simulation. Undoubtedly, it is necessary to apply economic methods to calculate TPP’s costs and benefits to different countries. But we should consciously realize that we will be unable to make some objective and rational judgments on TPP’s prospects and influences if we deviate from the United States’ return to Asia-Pacific strategy and ignore the fundamental interest disputes between China and the United States.

CHAPTER Seven

The Rise of China and the Adjustment of the International Order—A Case Study of China’s Participation in the Multilateral Trading System Song Hong* Abstract: China surpassed Germany and became the world’s largest exporter in 2009. One year later, China replaced Japan in terms of gross domestic product (GDP), and it became the world’s second largest economy, only behind the United States. What influences will China’s rise produce on the global economic order and the global governance structure? How will other countries adapt themselves to such changes and what policies should China adopt? Those are the key questions of this paper. With an analytical framework generally based on the realistic international theory and specifically based on “the rise of a power and restructuring in international relations,” this paper takes China’s participation into the world’s multilateral trading systems as an example to analyze and study these questions. The main findings are as follows: 1) The building up of trade and economic power has made China become one of the key members of the multilateral trading system and play a leading role jointly with other core members. 2) With the rise of its economic influence, especially the trade influence, China will not overturn or drastically change the world’s prevailing multilateral trading system. Instead, as one of the top traders in the world, China will serve as a strong force backing and safeguarding the established multilateral trade regime. 3) The rise of China will induce a new readjustment of the roles played by the existing key members in the multilateral trading governance structure, and it may trigger a rather long period of turbulence and friction among those members. So, this adjustment process needs active countermeasures from all parties. 4) China should be a key responsible stakeholder in the multilateral trading system and share the leadership with other key members. Keywords: The rise of China, adjustments to the international order, the multilateral trading system, adjustments of relations among major powers

I.  Introduction: The Rise of a Power and Adjustments to the International Order Competition among countries, especially major powers, is mainly based on their comprehensive national strengths, which come from their ­scientific * The Chinese version of this article was first published in Shijie jingji yu zhengzhi 经济与政治》  《世界   , World Economics & Politics (6) 2011. This is an abridged version with some data updated. Song Hong is Researcher of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences. He is also the Director of the International Trade Research Office. His email address is [email protected].

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and technological, economic, and military capability.1 The basic principles in this process are as follows: First, under the extant international order, given its national strength, a significant power usually gets its status accordingly and tries its best to boost it again; second, when its national strength-building reaches a certain level, it will try to change its extant status and a readjustment of the international order will be induced.2 This process is repeated and continued. As a matter of fact, such a principle serves as a basic logic for a ­power’s rise and adjustments to the international order. However, the causal link between the rise of a power and the change of its status and adjustment to the international order is not direct and mechanical like a simple mathematical formula. Rather, it depends upon the structure of the extant governance and international order. Furthermore, the link does not have one-direction causality it also runs another way. For example, a favorable international relation will facilitate the rise of a potential power. The following two factors will determine if a power can achieve a smooth rise and the international order can realize smooth adjustments accordingly: (1) the extant government structure of the international order and the strategy and attitude of the old big power or powers: In most cases, the old dominant power or powers usually takes or take available measures to squeeze and contain the rise of a potential power; (2) given a major boost to its comprehensive national strength, how does a rising or potential power use its national forces to acquire its status? In short, competition among countries and the adjustments of their national strengths and status also closely relate to the government structure of international relations. From the perspective of the theory of market economic structure, the rise of a big power can be divided into the following different scenarios: 1. A Monopolistic Market Structure—A Unipolar World in International Relations In a monopolistic market, the manipulator, either the buying or selling party, possesses the power of determining prices, production volumes, and snatching monopolistic profits. In a unipolar world, a dominant power usually exercises decisive global influences and dominates the extant 1  Paul Kennedy, The Rise and Fall of the Great Powers, A Chinese version, trans. Wang Baocun, (Beijing: Qiushi Press, 1988), 3–12. 2 The extant international order refers to international rules and standards set up by dominant powers centering on their own interests.



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international political and economic order. In this context, a potential power does not have much opportunity for making influential political and economic decisions. At the same time, if a potential power realizes its opportunity to rise, it will likely employ extreme methods to change the established world order. The international landscape that the world is undergoing is like this scenario. Since 1991, when East Europe experienced upheavals and the Soviet Union fell apart, which symbolized the collapse of the Cold War system, the United States became the world’s sole superpower. Under these circumstances, China adopted a low-profile diplomatic strategy. Such an advisable and long-term political strategy, worked out by later leader Deng Xiaoping (邓小平), together with the United States’ failure to adapt to the international environment where it acts as the sole superpower, especially the diversion of Washington’s attention to antiterrorism following the September 11 events, created significant room for China’s development. 2. The Two Sub-Scenarios of an Oligopolistic Market Structure The first scenario is duopoly and two-power struggle in international relations. Under a duopoly, competition between two dominant selling ­parties or two dominant buying parties will bring benefits to consumers and the entire situation, including the level of prices and production volumes. This situation will be better than a monopoly. A two-power confrontation in international relations will offer a potential power the chance for greater development. If a potential power can strike a balance between the two established larger powers, then it will enjoy more room to develop. At the same time, the rise of the potential power is also likely to change the established two-power confrontation scenario and form a new triangular relationship. The half-century Cold War formed after the end of World War II could serve as a vivid example in this regard. In that specific international environment, China played a role in triangular balance. It was an advisable strategy for China to adopt an independent and self-reliant foreign policy as well as moderately lean to one side at that time. The leaning-to-oneside foreign policy that China adopted during the 1950s and 60s, the selfreliant foreign strategy of independence adopted from the mid-1960s to the early 1970s as well as the US-allied strategy adopted in the 1970s and 80s to counter the erstwhile Soviet Union all created substantial space for China’s development during these decades.

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The second scenario is an oligopolistic structure and multipolarity in international relations. Under an oligopoly there are several possible outcomes for market competition, which are largely decided by struggles among the few market manipulators. In the real world, many markets belong to oligopolistic markets and market competition will benefit innovation. The multipolar world in international relations is a complicated structure that also fuels uncertainties. Nevertheless, such a structure also offers full developmental space for a potential power. Likewise, the rise of a potential power under the multipolar scenario is also unlikely to cause too many significant repercussions to the established world structure. Since China adopted its reform and opening-up policy and especially since the end of the Cold War, China sought and is still seeking a multipolar world that is the ideal structure for international relations. In forming a multipolar framework, China hopes that more countries will share the attention and pressure that the United States gives China. However, there are very slim possibilities for such a strategy to achieve success, since the poles, such as EU and Japan, are the allies of USA and have no intention of being in head-on rivalries with the United States. In addition, these multiple poles in the world do not possess the will to pursue cooperation with China and share its disputes and pressures during its rise. Therefore, the current world’s configuration is more like one superpower and multiple powers. 3. A Monopolistic Competition and the “Warring States” Era of International Relations In fully-fledged monopolistic market competition, individual manufacturers exercise small influences on the whole market, but each of them can play a certain role in its specific field. As a result, their competition can maintain a state of fully developed market competition. Monopolistic competition is the most realistic and more effective market competition manner in economics. When it comes to international relations, however, it is the most uncertain competition structure. This structure not only benefits the development and expansion of a potential power but also leaves the possibility for a potential power to be invaded or annexed by other old powers. Both the Spring and Autumn and the Warring States periods in China and the imperialist era in the late nineteenth century and early twentieth century can offer typical examples of this monopolistic competition. During these periods, strife, conflicts, and even fierce battles repeatedly broke out among different states. During the imperialist era in particular, large global powers reduced China to a country suffering untold insults and humiliations.



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In short, a multipolar world pattern will give the most opportunity to facilitate the rise of a potential power and ensuing adjustments to international relations. Such a structure will offer a comparatively large space for a potential power to develop, and at the same time this framework will serve to buffer the effects of its rise on international relations. But in reality, since the Oligopolistic Market Structure and monopolistic competition are not stable and feasible ones, a duopoly and a triple oligarchy will be more suitable for China’s rise. But, how can the rise of a potential power and the ensuing adjustments to international relations get along in the field of international trade, especially in the field of a multilateral trading system? On December 11, 2001, the 15-year-and-5-month talks about China’s accession to the WTO, which started on July 10, 1986, came to an end. In the 10 years after its entry into the WTO, China’s economy and foreign trade have achieved rapid development, and its trade status received a big boost in the world’s multilateral trading system. From the perspectives of a power’s rise and the adjustments to the international order, this paper makes an analysis of the development of China’s foreign trade and the transformation of its role in the multilateral trading system. The next section discusses the adjustment of relations among major powers under the multilateral trading system. The third section analyzes the benchmark and conditions for China’s entry into this system. The fourth section explores the rise of China’s trade and the adjustment of its status in the WTO. The last section contains conclusions. II. Adjustments in Relations among Major Powers under the Multilateral Trading System3 The world multilateral trading system is a product of human wisdom and proven by international trade practices over more than the past half century. If a country in the world adopts the market economic system economically and the rule of law politically it will not shake the rationale 3 The world’s multilateral trading system refers to various rules, agreements, and institutional arrangements governing regional and world trade activities. The WTO is usually viewed as an embodiment of multilateral trade rules, but it is in fact only a part of such a multilateral trading system. The UN Conference on Trade and Development (UNCTAD), a regime that governs the trade of world’s primary products, and some regional trade accords or organizations, such as the OPEC, APEC, and NAFTA, all constitute an important part of the world’s multilateral trading system. This paper is focused on the analysis of the world’s multilateral trading system represented by the WTO.

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behind this system. Such a system possesses established rules for international market competition for free and fair competition and trade liberalization. However, open and fair rules do not inevitably bring about equal results.4 Such a system is to the advantage of larger powers, but it will cause completely different results for weaker nations. Therefore, a country can only enjoy the benefits from this system and rules only after it becomes a more influential power.5 At the same time, under such an institutional environment, the rise of a country can change its own status more than it can have an impact on the whole system. The world’s multilateral trading system, or the international trade order based on WTO rules, is in essence aimed at restraining trade wars among different countries and creating a transparent and predictable environment for world trade. Under this order, trade disputes among big powers can be reasonably resolved through the disputes settlement system under the WTO framework. Within such a framework, there are little possibilities for trade disputes to escalate to trade wars and worsen to military wars. A small trading country can also take advantage of such rules to restrain some unreasonable activities carried out by substantial trading powers. For example, from 1995 to 2008, the number of trade lawsuits that developing countries of regions filed against developed countries accounted for 21.6 percent of the entire trade cases during the same period. The rise or fall of a big power will not cause significant effects on and influences to the whole international trade order. Its decision-making mechanism based on the principle of consensus will provide major powers with a platform to exert their influence, but it is more like a collective leadership mechanism that can restrict the influences of individual countries to a large extent. In this context, the rise or fall of a large power is not expected to produce considerable influences on the whole international system. In the world’s multilateral trading system, the rise of a power reflects the rise of its trading status and the build-up of its trade vengeance capability, which will raise its potential deterrence and bargaining capability in multilateral trade talks and possibly make it a crucial member to decide whether or not a final multilateral trade accord can be reached.

4 Li Xiangyang 李向阳, “Guoji jingji guize de xingcheng jizhi 国际经济规则的形成 机制 [The Formation Mechanism of International Economic Rules],” World Economics & Politics 9 (2006): 67–76. 5 The world’s extant multilateral trading system benefits strong powers, but also restricts the rise of a potential power. This poses a paradox and also one of the biggest challenges to a potential power during its development.



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However, a rising trading status does not mean a country can do anything it wishes. Even the United States, the world’s largest trading nation, cannot easily change its trade commitments. A country’s commitments to the world’s multilateral trading system can only be changed after it enlists endorsement from more than three quarters of WTO members. Besides helping a rising economic power gain related interests, becoming an influential power and a key member of the multilateral trading system, also means the power gains increased responsibilities and expanded obligations. While restraining larger powers, the world’s multilateral trading system also serves them. For example, the members of the world’s multilateral trade disputes settlement mechanism mainly come from the United States and European countries, and what they advocate are the spirit of rule of law in the United States and European countries. Another example is that this system may avoid disaster situations among major powers such as trade wars or currency wars. Thus, major WTO members are usually the most important backers and supporters of the world’s multilateral trading system. Also, major countries have played leading roles during talks regarding a country’s entry into the WTO, or its predecessor the General Agreement of Tariffs and Trade (GATT). One of the most important fruits the world’s multilateral trading system produced is the establishment of a broad multilateral market that is composed of markets of all WTO members. Accounting for more than 96 percent of the world’s total import and export volumes, the enormous multilateral market is attractive to any country in the world. The requirements raised by big trading powers for new members represent an access threshold to the world’s multilateral trading system. Some dominant powers usually capitalize on their privileges to set various preconditions for other countries’ membership to force them to make changes.6 III. The Threshold and Conditions for China’s Entry into the World’s Multilateral Trading System China was not only a new member to the world’s multilateral trading system but also an emerging trading power, especially in the field of textile trade, when China applied formally to join the multilateral trading system 6 For example, since the US always played a very tough role during the WTO accession process, especially of the large countries, Russia took more than 18 years, China more than 15 years to become the WTO members while Lao and other small countries only took several years to do the same thing.

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in the late 1980s. Some WTO members imposed numerous special restrictions and precautionary measures on China’s access to the multilateral trading body during its 15-year accession negotiation process. This also reflected the body’s attitude toward treating a new member. To some degree, the threshold and conditions for China’s WTO membership also determined China’s role and status in the multilateral trading system. 1. The Threshold of WTO Membership for China as a New Member The WTO was 54 years old in 2001 when China became a formal member. After eight rounds of multilateral trade talks over the previous 54 years, GATT signatories or later WTO members had already lowered their tariffs by a large margin and their trade systems were completely fulfilled the required WTO market economic conditions. Take tariffs as an example. In 2001, developed members already lowered their tariffs to an average 4.7 percent, while those in developing countries remained at 20.8 ­percent.7 As a candidate, China had to make an extensive tariff cut in a bid to keep closely in line with the tariff level of other WTO members. In its bid to join the WTO, China already slashed its tariffs by a large margin, but the WTO membership still demanded that China lower its tariff level from 15.3 percent to 9.8 percent.8 Talks with the United States and the European Union remained the most important in China’s bid to join the WTO. Talks with the United States in particular held 80 percent of the weight of China’s WTO membership negotiations. In November 1999, China ended bilateral talks with the United States, meaning all of the talks on its accession to WTO were coming to an end. Afterward, China also smoothly finished talks with the European Union. In 2001, China formally joined this organization.9

7 Sam Laird, “Market Access Issues and the WTO: An Overview,” in Development, Trade and the WTO: A Handbook, eds. Bernard Hoekman, Aaditya Matoo, and Philip English (Washington, D.C.: World Bank, 2002), 97. 8 China lowered the general level of its tariffs to 15.3 percent in early 2001 from 43.2 percent at the end of 1992 through four sizeable tariff cuts, with a nearly 65 percent tariff reduction margin. 9 Song Hong 宋泓, “Zhongguo yu WTO: yige xuexi, shiying he tiaozheng guocheng  中国与WTO一个学习、适应和调整过程 [China and WTO: A Process of Learning, Adapting and Adjustments],” in Mohe zhong de goujian—zhongguo yu guoji zuzhi guanxi de duo shijiao toushi 磨合中的构建——中国与国际组织关系的多视角透视 [Reconstruction in the Process of Frictions—A Multiple-Angle Review over the Relations Between China and International Organizations], ed. Wang Yizhou, (Beijing: China Development Press, 2003), 176–223.



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In its bid to join the WTO, China made the following commitments: (1) to open its service sector represented by telecommunications, banking, insurance, and specialized services to foreign investors; (2) to further develop the country’s openness to the outside world in such sectors as automobiles, petrochemicals, steel, and machinery; (3) to considerably improve the country’s investment and operation environment for transnational companies, for example, signing the TRIMs and TRIPS agreements and ITA. 2. China’s Entry into the WTO as a Non-Market Economy The international trading system established after World War II is built on the market economy. GATT and the WTO are also based on market economic principles.10 Tariff concessions, the cancellation of quota restrictions, the most-favored nation treatment as well as national treatment and fair trade, are only meaningful to market economies. In a non-market economy, say a planning economy, its commitments to the world’s multilateral talks can be offset by other measures. For example, during its multilateral trade talks, China committed to reduce the tariff on its vehicle imports by 10 percent, but at the same time it would raise domestic consumption tax on imported vehicles by 10 percent or take measures to limit the quota of vehicle imports, both of which would cause failure of its commitment to implement tariff concessions.11 There is not an absolute market economy in the world. Even in countries where market economies are established, there are also state-owned enterprises and market interventions. There exists a specific regulation, Article 17, in GATT on the trade of state-controlled products of market economies. Then how does the world’s multilateral trading system treat some non-market economies?12 Under the insistence of the United States and the European Union, two special articles were included in the ­protocol on China’s accession to the WTO aimed at limiting imports from China:

10 John H. Jackson, The World Trading System: Law and Policy of International Economic Relations, (Cambridge: The MIT press, 1997), 319–339. 11  Song Hong 宋泓, “Fei shichang jingji diwei yu zhongguo duiwai maoyi de fazhan  非市场经济地位与中国对外贸易的发展 [A Non-Market Economic Status and the Development of China’s Foreign Trade],” World Economics & Politics 10 (2004): 51–56. 12 It refers to the planning economy of the erstwhile Soviet Union, or current economies in transition. In these economies, a non-market factor plays a core role in their resources allocation and economic operation, and state or government interventions extensively exist in various economic activities.

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First, an article on “price comparability in determining subsidies and dumping” or Article 15 of the Protocol on China’s WTO Accession, a nonmarket-economy article, will last 15 years after China’s membership. This article stipulates that WTO members will use the cost or the price of the third party for reference when they intend to confirm whether or not products and services from China enjoy subsidies or dumping and which margins WTO members can apply, if there are any, unless China’s related enterprises can offer evidence that their products and services are made under market economic conditions. The second is the adoption a 12-year article on “transitional productspecific safeguard mechanism” or Article 16 of the Protocol on China’s WTO Accession. This article stipulates that WTO members can adopt some guarantee measures targeted at China in case they confirm the import of products and labor from China has caused market disruption to their domestic market. However, there are not similar restrictions are imposed on imports from other WTO members. These articles contain the following implications: Other WTO members can impose some prejudiced measures on China that do not agree with WTO rules; they can make some targeted counterattacks at will against exports from China, such as adopting a special safeguard article or conducting anti-dumping and countervailing investigations. With these privileges, other WTO members can easily attain their expected objectives concerning the China issue. All these prejudiced, China-targeted articles are equivalent to creating a justified restriction on the expansion of ­China’s foreign trade. 3. Harsher Articles Imposed on China in the Field of Textiles Textile and clothing, both as labor-intensive industries, have long been among China’s most important exports as a developing country since China adopted its reform and opening-up policy. From 1980 to 2001, textile and clothing maintained over 20 percent of China’s total commodity export volume. The proportion maintained about 30 percent on average from 1986 to 1995. In particular, the proportion of textile and clothing exports reached a peak in the mid-1980s. For example, 31.13 percent of China’s commodity exports came from textile and clothing in 1987. With the rapid rise in the export of China’s machinery and electrical appliances and electronics from the late 1990s, the share of textile and clothing in the country’s exports began to gradually decline. Since the mid-1980s, China has been one of the most important suppliers to the world’s textile market. Statistics show that China’s textile



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and clothing exports respectively accounted for 4.62 percent and 4 percent of the world’s total in 1980 and have ever since rapidly increased. They reached 7.52 percent and 8.38 percent of the world’s total textile and clothing trade volume respectively in 1989 and further ascended to 8.98 percent and 16.86 percent in 1994. The proportions were 11.26 percent and 18.87 percent in 2001 respectively prior to China’s accession to the WTO.13 At the same time, the GATT Uruguay Round also achieved some historic benefits, such as again sanctioning the textile trade that had long been kept out of the multilateral trading system and signing the Agreement on Textiles and Clothing (ATC) to replace the previous Multi-Fiber Agreement (MFA). The ATC stipulates that a worldwide quota system on textiles trade will be gradually phased out in three steps within a 10-year transitional period from 1994 to 2004. The significance of the textile and clothing trade to China and China’s competitiveness in them had prompted wide attention from other WTO members in the country’s bid to join the system. Thus, in the protocol on China’s accession to the WTO, a special mechanism aimed at preventing and restricting China’s textile exports, or a special safeguard system targeted at the textile trade, was designed. The clause stipulates that WTO members can adopt specific safeguards when textiles and clothing of Chinese origin are believed to be causing disruption to their domestic market and threaten the orderly development of local trade.14 Such a measure is not applicable to other WTO members with the same product categories. The clause became invalid on December 31, 2008. In the world’s multilateral trading system, there is a special safeguard clause guaranteeing the orderly market openness among WTO members. It stipulates that WTO members can temporarily raise their tariffs to protect local products if they face a rapid growth in imports that causes severe effects on local industries. However, such safeguards should be based on non-discrimination principles and should be applicable to all origins of import. The China-targeted textile and clothing safeguards was not on a non-discrimination basis. Its existence meant that a four-year restriction on the export of China’s textile and clothing was still maintained even after the global textile quota system was canceled. It was exactly because this clause

13 WTO, “Statistics Database,” http://stat.wto.org/StatisticalProgram/WSDBStatProgram Home.aspx?Language=E. 14 WTO, “Report of the Working Party on the Accession of China,” October 1, 2001, Passage 242, https://www.wto.org/english/thewto_e/acc_e/completeacc_e.htm#chn.

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that the European Union and the United States successively forced China to sign a new accord on textile and clothing exports in June and November 2005 and once again set a quota system on China’s exports. IV. The Change of China’s Status and the Transformation of Ιts Role The WTO entry offered China more potential for its trade and economic development. Furthermore, with China’s economic buildup and the rapid growth of its trade scale, this nation has also gradually become an important stakeholder and played a key role in the multilateral trading governance system. 1. China’s Rapid Development of Trade and the Change of Ιts Status after Ιts WTO Entry Over the past 10 years since its entry into the WTO, China’s foreign trade and its whole economy have achieved remarkable progress. In 2000, a year prior to its accession to the WTO, China’s exports were worth 249.3 billion US dollars, 5 percent of the world’s total export, ranking it fifth in the world. Its imports were worth 225.1 billion US dollars, 4.3 percent of the world’s total import volume, also ranking it fifth. China’s foreign trade achieved a leapfrog development since its WTO accession. According to statistics from the WTO, China’s export volume maintained a per capita growth of 17 percent from 2000 to 2009, which was the fastest in the world and also more than six times the world’s average during the same period.15 At the same time, the country’s import volumes achieved an average growth of 15 percent year-on-year, five times the world’s average of 3 percent, which was also the fastest in the world. The latest statistics also show that China’s exports grew 28.5 percent in 2010 from 2009, doubling the world’s average of 14 percent. Its import volumes also grew by 22 percent year-on-year, far higher than the world’s average of 13.5 percent.16 With the rapid expansion of its foreign trade, China’s status in international trade also changed dramatically. In 2010, China’s exports were 15 WTO, “Table 1.8, 1.9,” International Trade Statistics 2010, (Geneva: World Trade Organization, 2010), 13–14. 16 WTO, “Table 1.8, 1.9,” International Trade Statistics 2011, (Geneva: World Trade Organization, 2011), 24–25.



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1,578 billion US dollars, 13 percent of the world’s total export value, only behind the 27-member European Union. Its imports were 1,395 billion US dollars, 12.6 percent of the world’s total, ranking it third in the world, behind only the European Union and the United States. All these indicate that a new triangle is now taking shape as a new international trade landscape. Closely related with its rapid trade expansion, China has already become an important seller and buyer of many products in the world’s export and import markets. In 2009, for instance, China’s exports of electronic data processing and office equipment accounted for 33.99 percent of the world’s total, and its exports of telecommunications equipment, textiles, and clothing accounted for 29.38 percent, 28.34 percent, and 33.98 percent of the world’s total respectively. In the same year, China’s imports of fuel and mineral products accounted for 10.68 percent of the world’s total and the import of integrated circuit products and electronic parts 32.77 percent of the world’s total. A more detailed trade catalog will make more prominent the huge influence of China’s imports and exports on the world’s total foreign trade market. For example, the volume of China’s soybean imports was 41.4 billion US dollars in 2008, 52.8 percent of the world’s total import volume. The proportion further increased to 60 percent in 2009. The rising momentum has also been maintained in its imports of metals and metal minerals. In 2008, the import of­ China’s iron ores and nickel ores respectively accounted for 57.5 percent and 51.7 ­percent of the world’s total, and the proportion further rose to 67.5 percent and 57.5 percent respectively in 2009.17 To sum up, China rapidly developed into a trade power since its entry into the WTO. In an article titled “Does China matter?” carried in the Foreign Affairs Journal in 1999 Gerald Segal,18 director of studies at the London-based International Institute for Strategic Studies, believed that China would be a market with small influence on the world, especially on regions beyond Asia in terms of its economic weight. However, China’s status completely changed after a decade, and its demand and supply played a crucial role in the markets of many products. “Whatever China

17 Yao Zhizhong 姚枝仲, “Guoji dazong shangpin shichang xingshi huigu yu zhanwang 国际大宗商品市场形势回顾与展望 [An Overview and Prospect of the Market Conditions of International Bulk Commodities],” in Shijie jingji huangpishu: 2011 世界经济黄  皮书: 2011年 [The Yellow Book of World Economy: 2011], eds. Wang Luolin and Zhang Yuyan, (Beijing: Social Sciences Academic Press, 2011), 194–209. 18 Gerald Segal, “Does China matter?” Foreign Affairs 78 (1999): 24–36.

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buys will be more expensive and whatever it sells will be cheaper,” is how a popular saying puts it. Closely related with China’s changed trade status has been a continuous rise in its status in the WTO. In the WTO and GATT, the United States, the European Union, Japan, and Canada, four of the most influential members, formed the quadruple-party alliance.19 At multilateral trade talks, the four members usually first coordinated mutual stances and reached consensuses with each other, and then gradually exerted influence on other members to finally reach their expected consensuses. This four-party alliance played a key and lengthy role in GATT and the WTO until recent years when some emerging developing nations began to rise, (i.e. Brazil, Russia, India, China, and South Africa.) This is something that changed this traditional governance structure or mechanism. In the agricultural talks under the Doha Round, a new six-nation group formally formed, comprising the United States, the European Union, Japan, Australia, Brazil, and India. Likewise, the new six-party group also held talks at their ministers’ meeting in 2004 to coordinate mutual stances and further promoted their reached stances at the ministerial conferences of the WTO in 2006 and 2008. In July 2008, China joined the six-nation ministerial meeting. The core members of the WTO governance mechanism mainly came from major members of the agricultural talks under the Doha Round, but the entry of China, an emerging nation with ever-growing economic and foreign trade clout, has made the panel more democratic. 2. A Country on Which Most Restrictions Are Imposed The rapid growth of its trade volume and size as well as a rapid rise in its trade status have also brought China unprecedented trade restrictions, as indicated by a rapid increase in the number of anti-dumping, countervailing, and trade disputes targeted at the country. From 1995 to 2010, a total of 784 anti-dumping cases were initiated and 563 anti-dumping measures were taken by other WTO members against China, making China the largest victim in terms of the number of individual trade cases. The number of trade disputes involving China is far more than the total received by the following three countries ­combined.

19 Martin Khor and José Antonio Ocampo, “The Global Trade System and the Developing World,” prepared for discussion at the Conference on Global Economic Governance jointly organized by the Foundation for European Progressive Studies (FEPS) and Columbia University’s Initiative for Policy Dialogue (IPD) in Washington D.C., October 7–8, 2010.



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Over the past four years, the anti-dumping initiatives filed against China accounted for more than one-third of the world’s total, and more than 40 percent of anti-dumping measures worldwide have been targeted at China.20 China has also been the largest victim of the world’s countervailing initiatives and measures. More than 50 percent of the world’s countervailing initiatives and measures over the past four years have been targeted against China. Of the 40 China-targeted countervailing initiatives, 25 have come from the United States, nine from Canada, three from Australia, and one from the European Union, India, and South Africa respectively. Of 21 China-targeted countervailing measures, 13 have come from the United States and eight from Canada. China joined the WTO at the end of 2001, but it was also one of the countries to receive the most trade complaints within the WTO from 1995 to 2010, with 21 trade complaints and behind only the United States and the European Union. Of the 21 trade complaints submitted against China, 11 came from the United States, four from the European Union, three from Mexico, two from Canada, and one from Guatemala. All the 21 dispute complaints occurred after China’s entry into the WTO. From 2007 to 2012, the number of trade cases filed against China accounted for more than 20 percent of the world’s total. V. Conclusion: A Responsible and Active Leader In the world’s multilateral trading system, the rapid growth of a member’s trade volume and the continuous expansion of its trade scale will result in the change of its status and role. However, the process will not finish overnight and a significant time period is needed during which difficulties and setbacks will emerge: (1) In the world’s multilateral trade talks, the strength and status of a member state will be best served by the Principal Supplier Rule and the principle of reciprocity aimed at multilateral concessions. However as the rhythm of multilateral trade talks slows, a round of talks usually needs years, even more than 10 years and realizing a new status for a rising member will not occur overnight; (2) A traditional quadmember comprised of the United States, European Union, Japan, and Canada usually dominates the multilateral trade governance structure.

20 WTO, www.wto.org. All following data on trade disputes comes from the website.

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Such a typical oligopolistic structure is comparatively beneficial to the rise of emerging nations and also makes it easy to admit new members. But at the same time, the emergence and entry of a major power will not necessarily cause repercussions for the established system. Nevertheless, the rise of a new member and its entry into the multilateral trading system is also expected to break the established pattern to different degrees and trigger off a series of subsequent adjustments. China’s participation in the world’s multilateral trading system started from its entry into the MFA in 1983. During this lengthy process, especially over the past decade since its accession to the WTO, China’s foreign trade gained a leapfrog development, and its trade status has risen considerably. It is now the world’s second largest trading power. The launch of market-based economic reforms in 1978 to some extent meant China chose to abandon the previously advocated pursuit of a new international political and economic order. In this context, to participate in the world’s multilateral trading system became China’s unavoidable choice. The world’s existing multilateral trading system is the crystallization of the collective wisdom of market economies over the past more than a half century since World War II, although many improvements are yet to be made. However, it will come to no avail to attempt to build a new, alternate system, also based on market economic conditions, to replace the multilateral trading system. A single country has yet to accomplish building such a new structure. More importantly, the world’s extant multilateral trading system provided China with more room for its trade expansion and the rise of its trade status. It is exactly under this system that China’s foreign trade has achieved enormous development. In this regard, the textile and clothing trade has offered China an opposite example. Before resuming the contracting status in GATT, China first joined into the MFA in 1983. Since then, China had enjoyed the benefits of MFA for 12 years (from 1983 to 1994). However, when WTO was set up in 1995, only WTO member could enjoy the benefits of ATC which is the new multilateral agreement in textile and clothing, and the successor of MFA.). From 1995–2001, without the WTO membership, China can’t continue its benefits under the ATC anymore. As a result, it was exactly during this period of time that China’s textile and clothing trade as well as relevant domestic industries suffered an unprecedented predicament, with a large number of employees in these sectors laid off. In addition, the multilateral trading system is more aimed at regulating and restraining relations among big trading powers.



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As an emerging trade power, China needs such a multilateral trade platform and mechanism. To sum up, the first conclusion of this paper is that China should unwaveringly support and safeguard the world’s current multilateral trading system. This is not only in its national interests but is also a deserved duty and obligation China should undertake. The challenge posed by China’s rise has been the biggest and the most complicated in the history of mankind. From a Western perspective, China is a developing country. Not a single backward, developing country in history once led the whole world. From a Chinese perspective, it has also accustomed itself to its status as a developing nation and has built its diplomatic system on developing nations other than on developed nations. China is a non-Western nation, and Western countries still need a certain period of time to accept and adapt to China’s rise. China has also not abandoned, at least so far, its established economic and political systems. China is also a fast-growing economy and an emerging industrialized nation. Other countries do not usually accept a fast-growing nation easily. This situation is expected to last for a rather long period. China’s rise and its rapid economic growth, especially the rise of its national status, have exactly concurred with a financial crisis that has swept across Western countries. In this context, it will be difficult for Western countries to accommodate China’s rise and its improved national status in a calm attitude. From a Chinese perspective, it will by no means give up the chance to make full use of this crisis to boost its national status. The most unique aspect of China’s rise lies in the fact that China has long been viewed as neither a market economy nor a Western nation. The rise of a Western country will mainly result in power re-distribution within the Western world with few ideological adjustments. Following the disintegration of the Soviet Union and East European countries and the ensuring collapse of the Cold War system, Western countries strengthened their efforts and pressure to integrate China into the extant Western system. In this respect, Western countries should show patience and tolerance. At the same time, China and Western countries should also brace themselves for long-term friction and mutual accommodation. In addition, China’s rise directly resulted in the change of the core leadership structure of the world’s multilateral trading system. The key club changed from the traditional quad to a new one composed of six, the quad of the United States, European Union, Japan, and Canada, plus India and Brazil, or seven key members as a result of China participating

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in July 2008. In terms of its trade scale and trade influence, and a corresponding structure, the governance structure of the world trading system is more likely to be dominated by a new three-party group consisting of the United States, the European Union, and China. The inclusion of a lessdeveloped developing country will inevitably add difficulties to the formation of consensus among its core leadership group, no matter whether this core member group is a six-party, seven-party, or new three-party group. Compared with the traditional leading groups that consisted of Western developed countries, the new leading bloc will not only be more democratic in its decision-making process but also more time-consuming and it will find it difficult to reach final agreements. Thus, this gives rise to the second conclusion of this paper: China’s rise will induce some substantial adjustments to the world’s extant multilateral trading system and a rather long period of turbulences and friction. China should have enough patience in its pursuit of deserved respect and leadership power in the multilateral trading system. It should also maintain a calm attitude even if corresponding adjustments do not take place to the existing leading group of the world’s multilateral system. The United States acquired its leadership status of the present multilateral system only after its GDP ranked first in the world for an extended time period. In the short term, China should choose to gradually eliminate trade restrictions and restraints imposed on it. As the first step, China should slowly achieve its transformation from a non-market to a market economy. There are so far no objective standards within the world’s extant multilateral trading system to measure the transformation of a country from a non-market economy to a market economy. The United States and European countries set the criteria China now faces and they are thus highly politicized. A more practical choice for China now is to fulfill its WTO membership commitments and brace for the coming of the year 2016. Second, China should change its low-profile posture and play as an active WTO member. China should set up its own panel of experts for making reviews and judgments on any anti-dumping, countervailing measures, and safeguards as well as any trade disputes targeted at it. It should also actively make use of its importing power and influence as well as its foreign assistance and investment capabilities to fight and restrict China-prejudiced trade restrictive activities conducted by other WTO members. Such kinds of efforts are far more helpful than to strive for a market economic status without substantive significance. Third, in the field of primary products, it will be difficult and also slow for China to



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transform its strong purchasing power into a decisive price-setter. The disproportion between China’s trade scale and its pricing power is decided more by its trade structure than by its trade scale. A manufacturer and maker in global production networks, in most cases, will also be a pricetaker rather than a price-setter. The case is the same for labor-intensive industries. China’s enormous trade volumes largely comprise processing and labor-intensive products. However, in the field of mineral products, an oligopolistic sellers-dominated market structure has basically been set up in which buyers can exert very limited pricing influence. With the development of regional trade and bilateral trade in recent years, the world’s multilateral trading system has also been experiencing huge impacts. The policy focus and trend of some major powers have also shifted to regional and bilateral trade. Even so, the world’s multilateral trading system represented by the WTO will still play an elementary role in global trade. For example, some of the world’s regional and bilateral trade frameworks are to a large extent replicas of the WTO and their core contents are only its duplicates. From a long-term perspective, China, as a core member of the world’s multilateral trading system, should safeguard and support the normal operation and authority of this system. For example, China should adhere to its long-cherished principles on the establishment of a free trade area in a bid to pursue a high-quality regional and bilateral trade agreement. As a result, these conditions give rise to the third and also the last conclusion of this paper: China should actively guide the development of the world’s multilateral trading system and behave as a responsible power.

Part two

Global Economy

CHAPTER EIGHT

Global Economic Recovery: An Uphill Battle? Huang Haizhou, Li Zhiyong, and Wang Hui* Abstract: Since the global economic recovery started in 2009, the United States and other advanced economies have seen their public debt quickly rising as a result of their financial institutions’ balance sheet repair through capital injection and household debt reduction. Of the balance sheets of government, financial, household, and corporate sectors, only the corporate balance sheet remained relatively stable throughout the crisis, providing support for sustainable economic recovery. Based on an analysis of these balance sheets and policy orientation, this article concludes that global inflation and costs of capital, labor, and other inputs are set to rise. In contrast, the global growth is set to slow and global economic fluctuation will intensify, unless we can soon see major breakthroughs in technological innovations, in structural reforms in advanced economies, and in structural reforms in emerging economies and global governance. The global economy needs to brace itself for a bumpy recovery on the road ahead. Keywords: Global economic recovery, financial crisis, the balance sheet of government, financial, household, and corporate, economic growth, structural reform, global governance

I. Economic Recovery since the Global Financial Crisis Since it pulled out of recession, the recovery of the global economy had been continuing for three years by the second quarter of 2012. However, progress in this period has been uneven. The fast speed and substantive size of market rebounds in the initial stage of recovery (second half of 2009) were a reflection of market fears over another Great Depression and anticipation of the resumption of economic growth. Emerging countries witnessed economic recovery earlier than developed ones under the effects of government stimulus packages and the driving of domestic demand. China, as a main representative of emerging markets, was the first to pull away from the economic bottom. Developed countries also gradually ­extricated * The Chinese version of this article was first published in Guoji jingji pinglun 国际经 济评论 [International Economic Review] 4 (2011). Huang Haizhou is the Chief Strategist of China International Capital Corporation Limited. His email address is haizhou.huang@ gmail.com.

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themselves from a serious economic recession that the financial crisis incurred, but their recovery maintained a slower ­momentum compared with emerging markets (Figure 8.1). However, emerging nations also faced the growing pressures of asset bubbles and inflation because of excessive money supply during the global financial crisis. The climb in the prices of food, energy, and raw materials remains the main factor that fuels inflation. In the meantime, a new round of quantitative easing (QE) policy that the United States launched at the end of 2010 further spurred hot money to flow into emerging markets, exacerbating inflationary pressures. Serious inflationary pressures prompted emerging countries to successively tighten their monetary policies, which, together with geopolitics and other factors that fueled the rise of energy prices, have brought about negative effects on their economic growth and slowed down its pace. Out of worries over their economic prospects, central banks across the world gradually started a new cycle of loose monetary policies from the second half of 2011. Currently, the global economy still faces major uncertainties. The United States’ mild economic recovery momentum has not changed, but its high unemployment rate, depressed real estate market, and fragile corporate and consumer confidence mean that it is yet to cultivate an internal driving force for economic growth. It also remains questionable whether the United States can maintain its economic recovery momentum as its economic stimulus policies start to expire and government spending has to be slashed. Under the impact of a lingering debt crisis, the Eurozone also lacks a bolstering force for its economic recovery, and its possibility of plunging into a new recession in 2012 is growing. Mounting abhorrence and antagonistic sentiments among many Eurozone nations plagued by debt problems toward a protracted fiscal austerity policy have also brought the Eurozone’s unity and stability into question. At a time when demand in developed countries remains insufficient, a decelerating economic growth in emerging nations will add to the risk of “stagflation.” Following the rise and fall of global economic recovery, there have been several rounds of rise and fall in global financial market. In the initial period of economic recovery, investors’ appetites for risk stood relatively high, and thus began shifting investment from dollar reserves, US Treasury bonds, and other safe assets to stocks, to commodities, and to emerging markets. The moves in the international financial market exactly reflected increased appetite for risk: stock prices rebounded from bottom, commodity prices soared, and a large volume of funds withdrew from the United States, causing an imbalance in the US Treasury bond market and pushing up yields. The outflow of funds also lowered global demands on the



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Sources: IMF, CICC Research.

Figure 8.1. A Fast Economic Recovery in Emerging Nations (left) and their High Inflation Rates (right)

US dollar, and it consequently brought the greenback into a ­depreciating ­trajectory following its appreciation against other currencies in the context of the global financial crisis. With the escalation of the European debt crisis and a slowdown in global economic growth, however, investors reduced positions in risky assets and began withdrawing their funds from stocks, commodities, and emerging markets and again shifted to the US dollar and the national debts of developed countries. At the same time, increased volatility in the global financial market and the rise of risk premium also made it difficult to earn a stable return. II. Stimulus Policy and Economic Recovery The US subprime crisis triggered the 2008 global financial crisis, the root cause of which was the bursting of the asset price bubble, especially real estate prices. The low interest rate policy adopted by the US Federal Reserve for an extended period, excessively loose credit conditions by its financial institutions as well as a loose oversight from its supervisory authorities caused over-borrowing in the real estate sector. The leverage and debt levels of financial institutions and households, two major sectors, kept rising after 1980, causing a continuous accumulation of financial risk. When asset prices began declining, a confidence crisis began emerging, and the balance sheet of the two major sectors began deteriorating. The crisis began spreading from the financial sector to the whole economy and from the United States to the rest of the world. To tackle the crisis, maintain the stability of their financial systems, and spur economic growth in the wake of the global financial crisis, major economies in the world all adopted traditional monetary and fiscal

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Price 12/31/08 12/31/09

Stock Market

Performance %

12/31/10

12/31/11

FY2009

FY2010

FY2011 2009−2012

 

 

 

 

 

 

 

 

Russian RTS $ 620 India BSE SENSEX 30 9,647 Brasil BOVESPA 12,540 US S&P 500 903 UK FTSE 100 4,434 German DAX 4,810 China SHCOMP 1,821 France CAC40 3,218 Japan NIKKEI 225 8,860

1,370 17,465 21,673 1,115 5,413 5,957 3,277 3,936 10,546

1,688 20,509 22,240 1,258 5,900 6,914 2,808 3,805 10,229

1,402 15,455 19,706 1,258 5,572 5,898 2,199 3,160 8,455

121.1 81.0 72.8 23.5 22.1 23.8 80.0 22.3 19.0

23.2 17.4 2.6 12.8 9.0 16.1 −14.3 −3.3 −3.0

−16.9 −24.6 −11.4 0.0 −5.6 −14.7 −21.7 −17.0 −17.3

126.3 60.2 57.1 39.2 25.7 22.6 20.8 −1.8 −4.6

Currency

 

 

 

 

 

 

 

 

JPY/USD CNY/USD GBP/USD USD/Index EUR/USD

0.01 0.15 1.46 81.31 1.40

0.01 0.15 1.62 77.86 1.43

0.01 0.15 1.56 79.03 1.34

0.01 0.16 1.55 80.18 1.30

−2.4 0.0 10.8 −4.2 2.5

14.6 3.3 −3.5 1.5 −6.5

5.5 5.0 −0.4 1.5 −3.2

18.0 8.5 6.5 −1.4 −7.2

    Commodity Silver Copper WTI Sugar Cotton Gold Corn Aluminum Soybeans Wheat Gas

Price 12/31/08   11.3 141.0 44.6 11.8 49.0 884.3 407.0 1,513.8 972.3 610.8 5.6

12/31/09   16.8 334.7 79.4 27.0 75.6 1,096.2 414.5 2,203.5 1,039.8 541.5 5.6

Performance %

12/31/10   30.9 444.7 91.4 32.1 144.8 1,421.4 629.0 2,459.3 1,393.8 794.3 4.4

12/31/11   27.9 343.6 98.8 23.3 91.8 1,566.8 646.5 1,997.0 1,198.5 652.8 3.0

FY2009

FY2010

FY2011

2009−2012

 

 

 

 

49.3 137.3 77.9 128.2 54.2 24.0 1.8 45.6 6.9 −11.3 −0.9

83.7 32.9 15.1 19.2 91.5 29.7 51.7 11.6 34.0 46.7 −20.9

−9.8 −22.7 8.2 −27.5 −36.6 10.2 2.8 −18.8 −14.0 −17.8 −32.1

147.3 143.7 121.6 97.3 87.3 77.2 58.8 31.9 23.3 6.9 −46.8

Bond Yield

 

 

 

 

 

 

 

 

CN GOVT 10YR JP GOVT 10YR US GOVT 10YR

2.8 1.2 2.2

3.6 1.3 3.8

3.9 1.1 1.3

3.4 1.0 1.9

0.9 0.1 1.6

0.3 −0.2 −0.5

−0.5 −0.1 −1.4

0.7 −0.2 −0.3

Sources: Bloomberg, CICC Research.

Figure 8.2. Performances of World Stocks, Commodity, Foreign Exchange ­Markets, and ­Government Bonds Yield



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­ olicies in an effort to curb economic slowdown. Measures included: p lowering interest rates to a record low for the past 100 years, the United States, the United Kingdom, and Japan lowered their interest rates to near zero, adopting tax cut or rebate plans, directly offering household subsidies, and expanding public spending. At the same time, a series of other measures were also taken, including injecting liquidity into the market, recapitalization of financial institutions, stripping problematic assets from financial institutions and offering guaranteed credit in a bid to restore the credit market to a normal level. When traditional policies turned out to be ineffective, major economies also successively announced quantitative easing policies. In the context of a deteriorating international environment and a downturn tendency emerging in their own economies, many emerging nations also successively adopted various anti-cyclic macroeconomic ­policies (Table 8.1). III. An Analysis on the Prospect of Economic Recovery in Developed Countries through the Balance Sheet of Four Major Sectors An economy is usually divided into four sectors—government, financial, household, and corporate. To judge the prospects for economic recovery in developed countries and the whole world, one should first analyze the balance sheet of the four major sectors and their correlation and then, together with its policy trends, draw a conclusion. As matter of fact, the financial crisis is also a balance sheet crisis and pulling out of the financial crisis is also a balance sheet repairing process.1 Since the start of global economic recovery in 2009, the global economy headed by the United States displayed the following three major trends: (1) the continuous soaring of public sector debt; (2) recapitalization of financial institutions with a stricter oversight, tightened credit, and associated rising cost; (3) the decline of household debt level. Of the four major sectors—government, financial, household, and corporate—only the

1 Refer to Koo and Huang Haizhou for more details on the discussions of the nationallevel balance sheet: Richard Koo, Balance Sheet Recession: Japan’s Struggle with Uncharted Economics and its Global Implications (New York: John Wiley, 2003); Huang Haizhou 黄海洲, “Meiguo jingji heshixiu? 美国经济低迷何时休? [When will economic recession in the US end?]” International Economic Review 1 (2011): 24–31.

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Table 8.1. Rescue Policies Adopted by Major Economies since the Eruption of the Crisis Country/Organization United States

Policy Type Monetary Policy

Fiscal Policy

Policy Content Lowering interest rates. The US Fed Funds Target Rate was lowered from 5.25 percent to 0–0.25 percent and maintained unchanged for extended period; directly increasing liquidity; quantitative easing—the Fed injected liquidity into the market through direct asset purchases. A 168 billion US dollar rebate plan, a 700 billion US dollar Troubled Assets Relief Program, a 787 billion US dollar economic stimulus package, an emergency assistance programs for public, private, and bad debt-laden banks.

European Central Bank

Monetary Policies

To satisfy banks’ re-financing demands, European Central Bank raised its loans ceiling and extended its loans tenure from previously three months to one year; making seven cuts in its benchmark interest rate within eight months, lowering it from 4.25 percent in July 2008 to a record low of 1.00 percent in May 2009, but the timing of these rate cuts and their ranges both lagged behind the US; a quantitative easing policy.

China

Monetary Policy

A moderately loose monetary policy: the People’s Bank of China made six cuts on benchmark interest rates from September 2008 to the end of that year, lowered banks’ reserve requirement ratio by 400 basis points, and increased credit supports to small and medium-sized enterprises. A proactive fiscal policy: the central government worked out 10 major measures aimed at expanding domestic demand and promoting growth and launched a 4 trillion yuan stimulus package for infrastructure construction. At the same time, it adopted a bigger export rebate plan and increased supports for the growth of farmers’ incomes.

Fiscal Policy

Source: CICC Research.



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Sources: Federal Reserve, IMF, Haver Analytics, CICC Research.

Figure 8.3. Ratio of the US Total Debt to its GDP from 1952 to 2010 (left) and the Ratio of Debt Held by Various Sectors to GDP (right)

c­ orporate balance sheet remained in a relatively sound condition, laying a solid foundation for sustainable economic recovery. Since 1980, the level of private debt in the United States, especially debt held by its financial institutions and households, has kept rising, in contrast with the continuous decline in the savings ratio. However, the United States’ corporate and government sectors have had a comparatively limited borrowing level. As a whole, debt in the United States rose to 360 percent of its GDP in the second quarter of 2009 from 120 percent in the early 1950s (Figure 8.3, left).2 The ratio even rose to 382 percent if the value of overseas net investment is included. Of the four major sectors, the debt level of financial institutions and households has obviously accumulated over the past 30 years (Figure 8.3, right). Household loans mainly flew to the real estate market after 2000, directly bolstering real estate prosperity and sustainable price rises and, finally, unprecedented real estate bubbles. A similar problem has also existed to some different degree in other developed countries, such as the United Kingdom, Germany, and France. However, a crisis loomed large in the household balance sheet when home prices began declining, a crisis that directly turned the payment of mortgage loans from a potential risk to a reality.

2 The total debt refers to all debt held by the four sectors. Due to the limitation of data, the mutual debt-holding volumes have not been accurately calculated. For the United States, overseas holding of its national debt exceeds a half of its total debt, far higher than that of the Eurozone and Japan. The proportion of overseas holding of its corporate debts is also higher that that of the Eurozone and Japan. However, further studies are still needed for their detailed and accurate calculation.

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The leverage ratio of financial institutions also continuously rose in the context of globalization. Slack financial oversight, the long-term low interest rate policy worldwide, and well-developed financial innovations have accelerated the rise of such a ratio. However, the real conditions have usually been worse, given that asset risks hidden in balance sheets could not be fully reflected by their book values with the increase in the quantity of financial derivatives. Financial institutions suffered enormous losses after the outburst of the global financial crisis, contributing to the eruption of their balance sheet crisis. The household balance sheet crisis directly resulted in contractions in consumption demand, which, together with a credit slowdown among financial institutions following the outbreak their balance sheet crisis, negatively affected the real economy on the fronts of demand and investment and then plunged the balance sheet of the corporate sector, which constitutes an important component of the real economy, into a deep crisis. In the meantime, the corporate crisis also negatively affected the balance sheet of households and financial institutions because of the decline of household incomes, an increase in unemployment and the decline of savings, investment and financing activities, thus, incurring a vicious cycle within the three sectors’ balance sheets. A series of economic stimulus packages launched by the world’s major economies in the wake of the global financial crisis has, in essence, been a loose way to repair the balance sheet of the other three sectors through increasing the government’s balance sheet. This will inevitably result in the rise of government deficits. During the financial crisis, the ratio of government debt to GDP in major developed countries witnessed a tangible rise. This, however, did not lead to obvious changes in developing nations. Then what about the sustainability of their balance sheet repair work? Take the United States as an example. The balance sheet of its government has grown by a large margin. It increased from 8.7 trillion US dollars at the end of 2007 to 15.2 trillion US dollars at the end of 2011, 1.7 times the level prior to the crisis. In sharp contrast with this is the obvious decline in the debt level among the other three sectors after the crisis (Figure 8.3, right). The debt level of financial institutions experienced an obvious decline over the past three years due to their bad loan deduction, ­government recapitalization, and their voluntary efforts to lower the leverage ratio, as indicated by the decline of the ratio of their debt to GDP from 121 percent in the second quarter of 2009 to 89 percent at the end of 2011. Nevertheless, the debt-holding ratio of United States’ financial institutions is still



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28.3 percent of its total debt, two percentage points higher than 26 percent, their average level over the past three years. That means there is still space for further deleveraging (Figure 8.4, left). In comparison, the United States’ household debt ratio is already very close to its long-term average, indicating its debt proportion tends toward a reasonable level. The debt ratio of the United States’ corporate sector has also been on a downturn tendency over the past 30 years; it is now far below the long-term average, a tendency that indicates that additional debts taken by the corporate sector have been lower than other sectors. It also demonstrates that the corporate balance sheet remains in a good condition and its financial structure remains reasonable. Certainly, the most outstanding is a drastic rise in the government’s debt ratio, which already exceeds its long-term average level. The previous paragraph indicates that the adjustment to the United States’ debt ratios among its major sectors has been achieved mainly through drastically increasing government deficits and such a process is expected to come to its end. In fact, the US economy has shown signs of re-leveraging, as new changes in its bank lending and savings clearly reflect. Prior to the financial crisis, the volumes of its bank savings and lending maintained a steady growth almost at the same pace and the gap between them was very small. After the crisis, bank savings sustainably increased while lending witnessed a steep decline, which caused the gap between them to widen rapidly. This should be attributed to a very weak loan supply and demand in the whole economic system and the accelerated de-leveraging efforts made by the private sector. Starting from the middle of 2011, the real economy has had growing borrowing demands and banks have also shown a strong willingness to lend with the repairing of the balance sheet among households and financial institutions and the restoring of the credit market (Figure 8.4, right). All these testify that the United States has always been faster than other economies in their de-leverage and re-leverage cycle. From a long-term perspective, the United States, however, will be under pressure to lower its total debt volumes. Whether or not the United States’ financial institutions and government sectors will continue efforts to lower their debt levels will largely decide if the United States can attain this target. For financial institutions, realizing the target is more complicated given that it is related to the United States’ interest rate environment, its economic prospects, whether or not its real estate market can recover as well as the change in banks’ business model under a new supervisory system. The prospect of the US economic growth and inflation as well as

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Sources: Federal Reserve, Haver Analytics, CICC Research.

Figure 8.4. Proportions of Debt Held by the US’ Four Major Sectors to its Total Debt (left) and the US’ Bank Savings and Lending Volume (right)

the government’s capability for further borrowing will heavily influence whether or not the US government can lower it total debt volumes. Some market analysts believe that the United States still has much room to further increase its debts, citing the current 230 percent ratio of Japanese government debt to its GDP as evidence to prove the US government’s further debt-holding capability. However, it is the authors’ belief that there are two factors that will cripple the US government’s ability to do that. First, the US government’s further borrowing will inevitably depend on the savings of households and the corporate sector, and it will also squeeze credit that can otherwise flow to the private sector. This is quite different from why the public sector in Japan and other countries could increase their borrowing. The skyrocketing of Japan’s government debt at a specific historic time concurred with a very high household savings ratio, which is far higher than today’s US society. Second, the US government’s ability to borrow more will to a large extent depend on the market’s perception and ability. The enormous foreign reserves from emerging economies and the large oil revenues from oil exporters offered a vast funding resource for the US national debt issued over the past years and also lowered the yield of the United States’ long-term national debt. However, with the decline of the attractiveness of dollar assets, the dollar’s status as a leading international reserve currency is likely to decline. The debt to asset ratio, or leverage ratio, among various US departments can also help us draw a similar conclusion (Figure 8.5). The government’s debt to asset ratio over the past decades basically fluctuated around its average level, but it kept rising after the global financial crisis. This ratio in the corporate sector has been on a declining track. For households and financial institutions, their debt-asset ratios have similarly kept rising over



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Sources: Federal Reserve, Haver Analytics, CICC Research.

Figure 8.5. Debt-Asset Ratios of the US’ Four Major Sectors

Sources: Statistical Office of the European Communities, IMF, Haver Analytics and the Research Department, China International Capital Corporation Ltd.

Figure 8.6. Ratio of the Eurozone’s Total Debt to its GDP (left) and the Ratio of Debt to its GDP Held by Various Sectors (right)

the past 30 years, an indication that their leverage ratios have been continuously increasing. Nevertheless, their leverage ratios have both declined by a large margin, more than 25 percent, since the financial crisis. Similar to the United States, the debt level in the Eurozone has kept rising by a large margin over the past decades in terms of either its total debt or the debt held by individual sectors. Its total debt increased from about 300 percent of its GDP in early 1999 to the current 448 percent. The ratio will rise to 514 percent if its overseas net investment value is included. Unlike the United States, the debt level in the Eurozone has not declined since the global financial crisis (Figure 8.6). From the perspective of the debt held by individual sectors, the debt proportion of financial institutions has always been on the rise while the ratio has witnessed a decline for the corporate world and households, a tendency that has

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been achieved at the price of a rising government debt after the financial crisis (Figure 8.7, left). Generally speaking, despite enjoying a lower household debt ratio than the United States, the debt level in the whole Eurozone is still far higher than the United States (130 percent higher than the United States in terms of the debt-GDP ratio), and there have not been obvious signs of de-leveraging among its individual sectors. This shows that the Eurozone faces even harsher challenges than the United States in lowering its debt level. The outbreak of the European debt crisis in early 2010 exactly marked the start of such kind of debt adjustments. The leverage ratios among various Eurozone sectors also indicate that household and financial institutions’ debt-asset ratios continuously rose over more than the past 20 years. Although their rising momentum was contained to some extent after the financial crisis, signs of obvious adjustments have not emerged (Figure 8.7, right), as indicated by bank savings and lending conditions in the Eurozone. The volume of existing loans by Eurozone banks has not declined even after the global financial crisis, although their growth considerably decelerated from the pre-crisis period (­Figure 8.8, left). That means the Eurozone will be in the long-term throes of de-leveraging. Compared with other developed nations, Japan’s debt condition remains most worrisome. Japan’s total debt is now about 630 percent of its GDP— 300 percentage points higher than that of the United States. The ratio will decline to 580 percent if its overseas net investment is included, still higher than that in the Eurozone—and its government debt is still on the rise (Figure 8.9). This is the result of its ever-growing government spending over the past 20 years to curb a lingering economic recession. With

Sources: Statistical Office of the European Communities, Haver Analytics, CICC Research.

Figure 8.7. Proportion of the Debt Held by Four Major Sectors in the Eurozone to its Total Debt (left) and their Debt to Asset Ratios (right)



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Sources: Statistical Office of the European Communities, BoJ, Haver Analytics, and CICC Research.

Figure 8.8. Bank Savings and Loans in the Eurozone (left) and Japan (right)

the aging of its population and the decline of its household savings ratio, it remains a major concern if Japan’s domestic bond market can sustain the pressure from ever-inflating public debts. Currently, 95 percent of Japan’s national debt is in the hands of domestic investors. If it shifts its eyes to overseas for investment in its national debt in the future, then Japan’s low interest rate environment, from which its economy has benefited for many years, will change. This will cause Japan’s financing costs to rise and, thus, is unfavorable to its economic development. Notably, the debt level among Japan’s enterprises has come to stabilize since 2006 and is now on a moderate rise, an indication that Japan already extricated itself from a long-term economic recession. Enterprises also improved their balance sheet conditions and showed a stronger willingness to borrow for expanding production, an outstanding spot in the Japanese economy. However, Japan’s bank savings and loans data show that its real economy still had a very weak credit demand, a sign that means, so far, an unblocked channel for the transmission of Japan’s monetary policy to its real economy has not been established (Figure 8.8, right). The government-driven and asset-inflated economic recovery models are not only difficult to form a self-rectifying and internally-driven growth force, but they will also possibly bring a string of unpredictable risks to future economic recovery. Currently, the household debt in Germany, France, Italy, and other Eurozone countries is comparatively at a lower level while the United States is still making efforts to lower its household debt level. In terms of corporate debt, the United States, the United Kingdom, and the Eurozone’s core members remain in a healthier financial condition, but most of them are still in an ongoing de-leveraging process. Compared with them, Japan’s corporate sector witnessed a steady

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Sources: Bank of Japan, IMF, Haver Analytics, CICC Research.

Figure 8.9. Ratio of Japan’s Total Debt to its GDP from 1997 to 2010 (left) and Ratio of Debt to its GDP Held by Various Sectors (right)

Sources: Bank of Japan, Haver Analytics, CICC Research.

Figure 8.10. Proportion of the Debt Held by Japan’s Four Major Sectors to its Total Debt (left) and their Debt to Asset Ratios (right)

rise in its debt level. In terms of government debt, the United Kingdom, Germany, and France, however, are at a comparatively lower level. After experiencing a considerable decline, the leverage ratio of Japan’s banks now shows a rising tendency while the United States’ banks are still in their ongoing de-leveraging process. In general, the debt level of various sectors in many countries is still higher than their long-term average. In this context, to promote the return of their debt level to the long-term average remains the key to repair their balance sheet problems. However, this will undoubtedly result in the deceleration of their economic growth, unless some significant progress is achieved in developed countries as they push for scientific and technological innovation and structural reforms. There is also a need for emerging nations to promote their structural transformation and worldwide efforts for better global governance.



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IV. Risks Facing Major Countries and Their Policy Tendencies 1. The Exit of the US Fiscal Stimulus Policies Will Cause Its Economic Recovery to Decelerate, but Its Loose Monetary Policies Will Continue Facing the predicament of high deficit and high debt, the US government will have to phase out fiscal stimulus policies adopted during the global financial crisis, including the expiry of the tax cutting plan adopted by the George W. Bush administration and an automatic spending reduction program that will be enforced at the start of 2013. These will cause the United States’ economic growth to decelerate in the future if the United States does not form new stimulus plans. Over the past three or more years, the US Federal Reserve successively launched two rounds of quantitative easing (QE) policy to purchase assets on a large scale and lowered the benchmark interest rate to a record low in a bid to spur economic recovery. While striving to pull the US economy out of a recession unprecedented in decades, Ben Bernanke, chairman of the Fed, also won a positive reputation worldwide for his unremitting efforts. Under these circumstances, both the Fed and Bernanke himself do not want to withdraw stimulus packages too soon because it could put the US economy at the risk of hitting bottom again. In the year of the presidential election, maintaining a loose monetary policy also helped President Barack Obama stay in office. After launching QE2 at the end of June 2011 as anticipated, the possibility now remains low that the Fed will push forward QE3. However, the Fed will remain particularly cautious about any exit from the relaxed monetary policy. It even hinted that it will maintain the current low interest rate to the end of 2014. Although stabilizing employment and prices remains its two top mandates, the Fed has put more emphasis on the recovery of the employment market at a time when inflation does not pose a main threat to the US economy. Currently, the circumstances for the US economic recovery are still complicated. From an internal perspective, the US employment market is still in depression and its real estate market still remains fragile. From an external perspective, the escalation of the debt crisis in the Eurozone and an increased risk of economic hard landing in emerging countries will possibly deal a blow to US consumer confidence and postpone its economic recovery. A series of data recently published also indicates that the United States’ economic growth rate has decelerated and uncertainties for its economic recovery have increased. Against this backdrop, it will be an advisable choice for the Fed to stay at a period of policy observation.

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2. The Debt Crisis in Some Eurozone Countries Will Constitute a Deadly Injury to Their Economic Prospects Looking back at the European debt crisis over the past two or so years, one can divide the crisis into a few stages. The latest developments show that EU leaders have already realized the severity of the crisis and begun to put aside their disputes in a bid to seek systematic solutions. From the fourth quarter of 2011 to early March 2012, EU members not only reached consensus on continuously offering assistance to Greece but they also made a significant breakthrough on promoting fiscal integration and the establishment of the European Stability Mechanism (ESM), a longterm, counter-crisis mechanism. The European Central Bank also played a crucial role in countering the crisis. It has not only chosen to purchase national debts of badly battered countries in the secondary market, which has helped stabilize the national debt market, but it has also offered colossal volumes of liquidity—about 570 billion euros—to Europe’s banking system through long-term refinancing operations (LTROs), a move that eased market concerns over the banking system in the Eurozone and indirectly helped to boost its national debt market. Greece successfully carried out its debt restructure, but its debt level cannot be sustainably maintained; thus, there are large possibilities for it to carry out a new debt restructuring in the future. Not just Greece, the debt prospects of Portugal and Spain have also caused market concerns. The final settlement of the European debt crisis is certainly based on the resumption of the economic growth of Eurozone nations, the growth of their fiscal revenues, and their gradual efforts to pay off debts. To realize these objectives, Eurozone nations need to carry out sweeping reforms, which will be an extremely painful process. At the same time, the Eurozone needs to take practical measures to push for its fiscal integration, set some binding restrictions on member states’ fiscal revenues and spending to ensure their deficits and debt conditions do not run out of control, and regain market confidence. However, the bleak Eurozone economic prospects make it difficult for it to fundamentally defuse the lingering debt crisis. It is widely estimated that the GDP of the Eurozone will shrink 0.4 percent in 2012 and a moderate growth is only expected to emerge in 2013. As a whole, its 0.4 percent economic slide does not look too serious, but behind it are huge differences among different Eurozone nations. According to an IMF estimate, Germany will have a 0.6 percent economic growth in 2012 while Greece’s economy will slide to –4.7 percent and Spain to –1.8 percent. Various economic indexes so far also prophesize



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that the Eurozone will be bogged down in a long-term economic recession, as indicated by dampened household consumption, depressed commercial activities, a slow currency growth, a deteriorating employment market, and severe government fiscal austerity. At the same time, a protracted debt crisis added to the Eurozone’s political uncertainties. Since the outbreak of the debt crisis, many ­countries, including Greece, Portugal, Spain, Italy, and the Netherlands, experienced changes to government. Election results in France and Greece in May 2012 demonstrated that currently in the Eurozone, voters have had the whip hand over creditors, and economic growth proponents have gained advantages over austerity advocates. Francois Hollande’s election as French president added uncertainties to the Eurozone’s policy direction and resulted in the collapse of the consensus EU countries previously reached on the continuous adoption of fiscal austerity when they signed a fiscal bill. Moreover, as the leftist political party opposed to austerity and bailout has gained ground in Greece, the possibility of the debt-laden European nation defaulting on its debt and even withdrawing from the Eurozone has obviously increased. This, if realized, will trigger a domino effect in the Eurozone, seriously damage its stability, and even bring severe repercussions to the global economy and market. While adhering to austerity in the short term, the Eurozone will pin its hope of crisis settlement on self-helping measures within the European Union—including strengthening the ESM, pushing for its fiscal alliance, and even issuing unified Eurozone bonds—aid from the international community, mainly via the IMF, and the European Central Bank’s continuous expansion of its balance sheet to stabilize the market. But from a long-term perspective, the only way to realizing growth is to carry out reforms, including reform of the welfare system in high-welfare nations, reform of the rigid labor market as well as privatization of low-efficient state-run enterprises and the adoption of more measures to resolve the employment problem for young people, such as learning from Germany’s experiences. In view of a continuous rise in the Eurozone’s unemployment rate, especially among young people, the employment problem should be a top-priority issue to resolve. The Eurozone’s unemployment rate now stands at 10.9 percent, and it is as high as 20.8 percent for people under 25 years. Certainly, the enforcement of these measures will bring the Eurozone closer to a virtuous economic growth direction, but cannot guarantee it can extricate itself from a lingering debt crisis. At the same time, reforms will result in the redistribution of interest and touch the vested interests of interested groups, and will encounter substantial

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d­ ifficulties on the way. Greece’s economic privatization and its loosening of the labor market also indicate the difficulty of national restructuring. However, the Eurozone will have very gloomy prospects and even come to a dead end without reforms. 3. Measures Adopted by China and Other Emerging Nations to Forestall “Stagflation” China’s recent economic data indicates its demand insufficiency and increased pressure to digest accumulated stock. The newly increased loans, its monetary supplies, and real interest rates all demonstrate that China still faces a comparatively tight monetary policy. Due to an equivocal economic outlook in developed countries, China is expected to encounter huge difficulties improving its external demand conditions in the short term, and its investment growth rate is also expected to further decline. The country’s current economic slowdown is a combined result of its slowed supply and demand, reflecting the concurrence of its slowed long economic cycle and short-term total demand. From the perspective of supply, the change of population structure will result in the deceleration of the potential economic growth rate. From the perspective of demand, China’s domestic enterprises deleveraging efforts and its ongoing effort to defuse real estate bubbles will aggravate a decline in its total demand, thus, contributing to its economic slowdown. Despite some differences in their economic development levels, emerging nations have all displayed signs of economic overheating with the previous output gap disappearing. Due to a fast rise in energy prices in previous months, inflation in a majority of emerging nations is still at a high level and the outlook for their economic growth does not remain optimistic. Consequently, most of them usually make a difficult choice between tightening and loosening monetary policies. However, emerging nations are usually more inclined to turn to a loose monetary policy in a bid to maintain their economic growth. This, together with the longterm loose monetary policies adopted by the US Fed and other central banks, will sow the seeds for rising inflation in the future. Whether or not emerging nations can avoid a terrible “stagflation” will be decided by what regulatory policies they will adopt and to what extent these policies will be enforced. It will also be decided to a large degree by the price trends of global commodities, monetary policies adopted by developed nations, and the prospects for their economic recovery.



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V. A Tortuous Path for Global Economic Recovery Global economic recovery has experienced a three-year arduous process since early 2009, and the challenges ahead bear the following ­characteristics. 1. Bottlenecks Quantitatively Easing Policies Will Encounter in Spurring Economic Recovery The Great Depression offered policymakers and economic analysts numerous experiences and lessons in how to deal with a financial crisis. The Gold Standard system played a key role in the spreading of the Great Depression. Many countries gradually extricated themselves from deflation and pulled out of recession only after they abandoned the Gold Standard system and increased monetary supplies. For countries with a restrictive monetary flexibility, the sooner they freed themselves from the Gold Standard, the sooner they pulled out of economic deflation. Currently, many scholars, including incumbent US Fed Chairman Bernanke, studied the Great Depression in depth and have a profound understanding of it. Unlike what many countries did in the wake of the Great Depression, the US Fed made a very rapid response to the 2008 financial crisis, lowering its benchmark interest rate to nearly zero and launching two rounds of QE. It also purchased mortgage-backed securities (MBS) and national debts and injected into the market a large volume of liquidity within a short period. Facts proved that a series of actions taken by the Fed aimed at restoring the flagging credit market to normal, including injecting liquidity into the market, capitalization of financial institutions, stripping them of troubled assets, and offering guaranteed credit, helped the US economy avoid a recession. Central banks in Europe, Japan, and the United Kingdom also implemented particularly relaxed monetary policies in a timely manner. Although there is not much space for their traditional interest rate policy to play a larger role, these regions successively adopted a quantitative easing monetary policy. It was the first time in history that the world’s major economies implemented the quantitative easing policy in such an extensive manner. The quantity-based loose monetary policy adopted by Japan earlier to tackle the “liquidity trap” since 1999 has played a certain role in lowering fund costs, expanding money supply and preventing deflation. Nevertheless, a long-term de-leveraging process in which Japan’s corporate sector has been involved has seriously weakened their credit demand and

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thus stunted the role of the quantitative easing monetary policy in stimulating domestic prices and demand. The bad debts of the domestic financial sector and colossal government debt also restricted the role of Japan’s quantitative easing monetary policy. As a matter of fact, preconditions for quantitative easing monetary policies to work smoothly is that financial institutions should gradually complete their bad debt ­disposal and capital re-injection, and gradually increase their willingness to lend. Only under these circumstances, can borrowing and lending among financial institutions gradually return to normal, because they do need to mutually worry about balance sheet conditions, and can their lending to the private sector resume. However, Japan made sluggish progress in bank bad debt disposal during the period of a quantitative easing monetary policy. A result that is almost certain for the implementation of a quantitative easing monetary policy, as a way to prevent deflation, is the increase in money supply. The policy does help stimulate demand in the short term, but it will push inflation higher in the long run. Whether or not it can ensure economic growth enters a normal trajectory also remains uncertain. A quantitative easing monetary policy will result in considerable currency depreciation and disrupt the previous stable economic growth and price expectations. To come back on to a new and stable growth and a normal price track, however, the emergence of new growth forces is needed. In fact, economic growth immediately stagnated once monetary policies were slightly tightened for a long period after the Great Depression. For example, the United States’ economic recession in 1937 was incurred by the Fed’s move to raise banks’ reserve requirement ratio out of concerns over inflation and a slowed pace of government spending. The United States’ economy entered a real and sustainable growth track only after the outbreak of World War II, especially after 1942 when Washington increased dependence on war to drive demand. Through fuelling inflation, it seems that a superficial economic crisis can be resolved, but a rooted crisis can only be resolved via boosting economic growth. Only by achieving significant progress in their scientific and technological innovation and structural reforms, as well as in advancing better global governance as soon as possible, can developed countries improve their economic growth rate. 2. Developed Countries Have Become Heavily in Debt The issue of high deficit and high debt, almost without exception, has plagued the world’s major developed countries. The European debt ­crisis



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Sources: Bloomberg, CICC Research.

Figure 8.11. A High Deficit and High Debt in Developed Countries (by the end of 2011)

that erupted in early 2010 sounded an alarm bell for policymakers and economic analysts. By the end of 2011, Greece’s fiscal deficit had accounted for 9.1 percent of its GDP. The ratio was 8.3 percent in the United Kingdom, 8.9 percent in Japan, and 3.9 percent in Italy. In terms of public debt, Greece had a debt to GDP ratio of 165 percent. The ratio was 120 percent for Italy and 86 percent for France. Japan’s public debt to GDP ratio had even been as high as 232 percent by the end of 2011. However, what concerns people most is still the United States’ deficit and debt problem (Figure 8.11). There have been controversies and disputes among economists over what is a reasonable debt level although all focus attention on the connection between debt sustainability and the level of economic growth.3 Both Reinhart and Rogoff believe that it will be extremely dangerous if the debt of developed countries exceeds 90 percent of their GDP, claiming the debt above such an “alert level” will lower their economic growth rate by more than a percentage point. They believe that the “alert level” is lowered to 60 percent for developing countries and their economic growth will be cut by two percentage points if their debt remains above that

3 Haizhou Huang and Danyang Xie, “Fiscal Sustainability and Fiscal Soundness,” Annals of Economics and Finance 9 (2008): 239–251.

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Sources: BEA, Treasury Direct, Bloomberg, CICC Research.

Figure 8.12. The Explosive Growth of the US Total Federal Debt in Recent Years (left) and its Long-Term Fiscal Deficit (right)

level.4 Paul Krugman, however, holds a different viewpoint. He believes that it is unreasonable to draw an “alert level,” saying a high debt level is caused by low economic growth rather than the other way around.5 Fed Chairman Bernanke also believes that no evidence or theories can explicitly prove what levels of debt will have unfavorable effects on a country’s economic development. But he agrees that a high debt will cause high costs and claims that the US government should take measures to lower its fiscal deficits to a sustainable level.6 In any case, the high debt level in developed countries will restrict the flexibility of their fiscal policies and hamper their economic recovery for a long period. To salvage the slowed US economy during the financial crisis, the US government had to increase government spending and expand its fiscal deficits. Since then, its total debt has experienced an explosive growth. By the end of 2011, the United States’ total debt had reached $15.2 trillion, 98 percent of its GDP (Figure 8.12). The US government deficit amounted to $1.3 trillion in 2011 and is expected to be at the same level in 2012. It will gradually restore to a normal level only after 2014. Although the US government and Congress both vowed to slash its deficit by $4 trillion in the coming years, the US national debt will continue to increase and is expected to amount to about $20 trillion within six years. The debt liability on the US federal government would be more than $60 trillion if 4 Carmen Reinhart and Kenneth Rogoff, This Time Is Different: Eight Centuries of Financial Folly, (New Jersey: Princeton University Press, 2009). 5 Paul Krugman, “Bad Analysis at the Deficit Commission,” The New York Times: The Opinion Pages, May 27, 2010. 6 Ben Bernanke, “Speech before the National Commission on Fiscal Responsibility and Reform: Achieving fiscal sustainability,” Federalreserve.gov, April 27, 2010.



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its liability beyond the balance sheet is also included. This is one of the important reasons why Standard & Poor’s downgraded the prospects for the United States’ AAA long-term credit rating from “stable” to “negative.” Besides federal government debt, the states and local governments have also been heavily in debt. The United States will not plunge into a debt crisis like that in the Eurozone in the short term, but its debt problem will pose the biggest systematic risk to the global economy and financial markets if it cannot effectively cut its fiscal deficit and lower its debt level. How its economic recovery will continue serves as a key to whether or not the United States can lower its debt level. The US fiscal deficit is expected to decline and the market will regain confidence in dollar assets if it obtains a sustainable and stable economic recovery. But the emergence of a debt crisis is possibly only a matter of time if its economic recovery encounters obstructions or again plunges into a recession. 3. The Lack of New Economic Growth Forces in Developed Nations The development of IT-led high technology drove the high-speed growth of the US economy at the end of the 1990s. A boom in consumption and the real estate market bolstered its high-pace economic growth from 2003 to 2007. However, it became increasingly obvious that developed countries fall short on new economic growth forces. New energy, new information technology, and bio-medicine manufacturing based on stem cell research will possibly become new economic growth forces, but, so far, they alone are not enough to drive the growth of the whole economy. 4. The Arduous Advancement of Structural Transformations in Global Economic Re-Balancing Global imbalances are an inevitable result of the excessive expansion of global demand in the dollar-centered international financial system. Global economic imbalances are also reflected in a high savings ratio and low consumption in some emerging nations, including China, and their government and private investment-driven economic development models. In the United States, the main embodiment is excessive consumption, insufficiency of investment, and continuous absorption of exports from emerging markets. For a period of time after the global financial crisis, the US current account deficit did experience a level of decline and, at the same time, its household savings ratio witnessed a rise. However, such passive

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Sources: Bloomberg, CICC Research.

Figure 8.13. Difficulties for Continuous Improvement of the US Current Account Deficit and Household Savings Ratio

re-­balancing did not last. Three years after the global economy embarked on its recovery process, the old model of “manufactured by China and consumed by the US” seems to have emerged again (Figure 8.13). China’s economic growth is still dominated by investment while the US economic recovery is driven by consumption. Besides the United States, Japan and some Eurozone countries plagued by the debt crisis all need a long process of reforms before regaining their economic vigor. Having been plagued by low domestic demand and an aging population, Japan’s economy has been bogged down in long-term deflation. Without reforms, Japan’s economic prospects will remain bleak. The fundamental factor that plunged Greece heavily into debt are the defects of its economic foundations, including excessive dependence on credit-based consumption for economic growth, an unreasonable economic structure, and under-competitiveness as well as an extremely rigid labor system. To fundamentally resolve their debt problems, these ­countries must carry out major surgery on their economic structure and push for large-scale reforms instead of debt restructuring alone. It is predicted that global economic restructuring will be a very long and painful process. 5. Energy Issue Will Restrict Global Economic Recovery Political turbulences that occurred in the Middle East and North Africa in 2011 pushed oil prices higher in the short term and caused mild effects on the global oil market. That also demonstrates that the energy issue



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will still restrict global economic recovery and development for a long period. It will be difficult for new energy, on which the market once pinned great hopes, to replace traditional energy any time soon because of its inherent problems as well as considerations from various countries over their own interests. Oil is still expected to hijack the future of the global economy. VI. Ways to Extricate from Economic Development Dilemma The dilemma facing the global economy does not mean there are not ways out. Developed countries should first focus on resolving their problems of high deficit and high debt. Throughout history, there have been many countries that embarked on a stable economic recovery and became prosperous after effectively resolving their debt problems. Currently, the most practical and feasible way so far for the Eurozone to resolve its debt crisis is to carry out debt restructuring under the auspices of the European Union, alleviate debt pressures on its debt-laden member states, strengthen a systematic assistance mechanism, and advance fiscal integration. At the same time, debt-stricken countries should carry out sweeping reforms of their real economies to enhance their competitiveness. While pushing for fiscal austerity, how to realize economic growth as early as possible now poses a big difficulty in the Eurozone. Japan also faces the task of slashing debt and reforming its economic structure to rejuvenate economic vitality at a time when its population is increasingly aging. The US government has long realized the importance of fiscal balance, but numerous difficulties lay on the way to its fulfillment. As the first step toward this target, the Obama administration has planned to cut $4 trillion fiscal deficit within 10 years. However, the Obama administration still needs to carry out reforms in social welfare, medical care, insurance, taxation, and in the military sector to effectively check the momentum of its fiscal deficit inflation. Scientific and technological development still remains the most important factor to boost productivity and social development. Therefore, allocating more resources into scientific and technological research and development and trying to find out new growth forces will serve as the most fundamental way to resolve the global development dilemma. Technological breakthroughs in new energy, new transportation tools, bio-­medicine, and new-generation computers and telecommunication systems are expected to change mankind’s future living, working and

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t­ raffic behavior, improve people’s living conditions, and promote a leapfrog development in the global economy. At the same time, developed countries should also break established barriers, relax limits on high-tech exports to emerging nations, and expand the scope of their technological transfers, which will be another economic growth point developed countries can utilize well beyond the traditional goods and services trade. The United States and other developed Western countries should take a leading role in this regard. The United States still boasts the world’s best infrastructure—talents, facilities, and funds—for scientific and technological research and development as well as a good environment—a well-­developed corporate structure, incentive mechanism, and capital market—for commercialization. Emerging countries such as China should strive to catch up with their forerunners in these aspects to gradually realize their industrial upgrading and economic structural transformation. Global rebalancing remains an inalienable step toward realizing the sustainable and balanced global economic development. To promote such a type of rebalancing, the world should break the established model of “manufactured by emerging countries and consumed by developed countries.” Emerging countries should lower their excessive savings, increase consumption, and advance reforms of their social welfare and taxation systems. Developed countries should increase investment in a bid to further boost their competitiveness. Currently, worldwide investment remains insufficient rather than abundant. In particular, there exists a serious shortage in infrastructure investment in many emerging nations, such as India, which has seriously restricted their economic development. Because of insufficient investment, developed countries’ infrastructure, such as in the United States is now outdated and backward. With the increase of globalization, any country alone is now incapable of resolving issues such as strife, environmental problems, biological challenges, resource needs, and climate threats, a fact that highlights the importance of global governance. To promote better global governance, all countries in the world, while preserving their established government and management mechanisms and power, should try to strengthen mutual communication and coordination in a bid to seek ways to resolve common global issues. To acquire more balanced and sustainable development of the world economy in the future, both developed and emerging countries should pursue further cooperation and exploration in global governance, reduce friction, strengthen cooperation, and optimize global logistical chains to share global common wealth. In this regard, the G20



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once played an important role in coordinating stimulus fiscal policies among various countries and ensuring their economic recovery. Given that globalization will continue and deepen, no countries should adopt any form of protectionism simply because of difficulties in the progress of their economic recovery. VII. Conclusion The root cause of the 2008 global financial crisis was the real estate bubbles, and its structural condition is the continuous rise of debt levels and the leverage ratio among financial institutions and households in the United States and other developed countries since the 1990s. An excessively loose monetary policy and slack supervisory mechanism helped to create the conditions for its emergence. Since the start of the global economic recovery in 2009, the global economy led by the United States has displayed the following three trends: (1) the level of public debt has kept rising; (2) financial institutions have been recapitalized and have adopted stricter oversight, resulting in tightened credit and its rising cost; (3) people have tried to lower their debts. Of the four major sectors—government, financial, household, and ­corporate—only the corporate balance sheet has remained in a ­relatively sound condition, laying a firm foundation for sustainable economic recovery. Based on the analyses of the balance sheets of the four major departments and their policy trends, the authors believe that the rise of global inflation and the cost of funds and other items as well as economic growth deceleration amid wider fluctuations will remain an inevitable result unless some major progress is achieved in scientific and technological innovation, structural reforms are pushed forward by developed countries, structural transformation is advanced by emerging nations, and there are worldwide efforts for better global governance Global economic recovery will face a tortuous road. Of all factors that influence economic recovery, the effect of stimulus policies will decline. The high debt level in developed countries, their lack of new growth forces, as well as energy restrictions and difficulties in realizing rebalance; will also serve as the most important factors. All these factors are expected to restrict global economic development for a comparatively long period. Nevertheless, an uneven road ahead does not mean there is not a way out. Practical efforts to push for structural transformation and global economic rebalance are key to resolving the current global economic dilemma.

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Developed countries should endure the throes of reform and try to lower the levels of their fiscal deficit and debt. Emerging nations should advance economic structural transformation and improve economic efficiency. At the same time, both developed and developing countries should make further efforts to reduce mutual friction and strengthen mutual cooperation. Increased input into scientific and technological research and development is also needed to resolve the energy bottleneck and seek new economic growth points. The global economy needs to brace for a tortuous advancement on its road to recovery.

CHAPTER NINE

Structural Changes of Global Economy and New Challenges of Emerging Economy Zhu Min* Abstract: One of the most significant features of global economic recovery after the financial crisis is the “dual-speed recovery” of both developed economies and emerging economies. The decelerated growth of developed economies positioned the emerging economies, for the first time, as the dominant force in global economic growth. The center of gravity for global economic growth has shifted from developed economies to emerging and developing economies, and this has a profound structural impact on all aspects of the global economy. Although emerging economies are currently growing at a good pace, they need to fundamentally readjust their structure for sustainable growth, which will not happen automatically. Only through profound structural reforms in their growth models, policies, lifestyles, and other areas, can emerging economies meet their imminent as well as mid-to-long term challenges ahead. Keywords: Global economic structure, center of global economy, emerging economies, model of economic growth

I. The Changing Situation of the Global Economy The global financial crisis that erupted in 2008 profoundly changed the global economic and financial situation. The most significant characteristic of the global economic recovery after the financial crisis was the “dual-speed recovery” of both developed and emerging economies. Due to the weakening of economic growth in developed economies, emerging economies have become a driving force in global economic growth for the first time. Developed economies were first affected by the US financial crisis, shown by the collapse of Lehman Brothers, which decreased both total aggregate supply as well as total aggregate demand. The European fiscal and banking crises that resulted from the sovereign debt crises of Greece, * The Chinese version of this article was first published in Guoji jinrong yanjiu《国际 金融研究》Studies of International Finance (10) 2011. Zhu Min is Deputy Managing Director of the International Monetary Fund and Vice President of the China Society of World Economy. His email address is [email protected].

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Ireland, and other struggling European countries subsequently accelerated the financial collapse in the United States. The slow recovery of their financial systems and the increasing debt levels of these countries severely restricted the governments’ use of fiscal resources to stimulate their economies. The unemployment rate remained high with weakened consumption and slow economic growth. The fundamental financial structures of developing and emerging economies, however, were not severely damaged by the crisis; the decline of developing and emerging economies were mainly the result of a significant decrease in external demand caused by the global financial crisis. Demand quickly rebounded after implementation of economic stimulus policies, and robust economic growth continued. According to the statistics and forecasts of the International Monetary Fund’s World Economic Outlook, global economic growth in 2009 was –0.6 percent, of which –3.7 percent came from developed economies, and emerging and developing economies actually contributed a positive growth of 2.8 percent, the same as South Sahara African economies did. In 2010, the global economy rebounded and its growth increased to 5.1 percent, of which emerging and developing economies had a growth rate of 7.3 percent, more than twice the growth rate of 3.1 percent from developed economies. In 2011 and 2012, our forecasts indicate that global economic growth will continue this pattern of “dual-speed recovery.” Current sovereign debt crises in developed economies are putting further restrictions on the possibilities of more stimulant policies for developed economies. The average global current deficit in 2010 accounted for 5.7 percent of global gross domestic product, of which 7.7 percent was from developed economies and 3.8 percent was from emerging and developing economies. From 2007 to 2010, the average global government debt changed from 57.6 percent to 71.2 percent of GDP, an increase of 13.6 percent. Developed economies increased from 73 percent to 96 percent, a total increase of 23 percentage points, while emerging and developing economies had an almost insignificant increase from 36 percent to 36.1 percent. It is estimated that in 2015, sovereign debts for developed economies will increase to 106 percent of GDP, a 10 percent rise, while sovereign debts in emerging and developing economies will decline to 30 percent of GDP, a drop of 6 percentage points. The average unemployment rate for developed economies was 8.2 percent compared with the emerging and developing economies average of 4 percent (Table 9.3). The center of gravity for global economies is slowly shifting from developed economies toward developing and emerging economies. For a significant length of time before the crisis, the contributions of emerging



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Table 9.1. Global Economic Growth (percent) Global

2009 2010 2011 (Estimated) 2012 (Estimated)

Developed Economies

–0.6 5.1 4.0 4.0

Emerging and South Sahara Developing African Economies Economies

–3.7 3.1 1.6 1.9

2.8 7.3 6.4 6.1

2.8 5.1 5.4 5.8

Table 9.2. Economic Growth of Select Countries (percent) US Eurozone UK 2009 –3.5 2010 3 2011 (Estimated) 1.5 2012 (Estimated) 1.8

–4.2 1.8 1.6 1.1

Japan China India Brazil Russia

–4.9 –6.3 1.,4 4 1.1 –0.5 1.7 2.4

9.2 10.3 9.5 9.0

6.8 10.1 7.8 7.5

–0.6 7.5 3.8 3.6

–7.8 4 4.3 4.1

Table 9.3. Fiscal Deficits Unit: Proportion of GDP (percent)

2009 Fiscal Deficit 2010 Fiscal Deficit 2011 Fiscal Deficit 2012 Fiscal Deficit 2007–2010 Changes in Government Debt 2015 Government Debt (Estimate)

Global

Developed Economies

US

Emerging and Developing Economies

–6.7 –5.5 –4.8 –3.7

–8.8 –7.6 –6.7 –5.3

–12.8 –10.4 –9.7 –7.8

–4.8 –3.6 –2.6 –2.1

57.6–71.2

73–96

36–36.1

106

30

and developing economies to global economic growth remained around 30 percent of total global economic growth, and they had 30 percent of global economic output. In 2010, however, their contribution increased to 70 percent of global economic growth, and in the past two years emerging and developing economies accounted for two-thirds of global economic output. The contributions of emerging and developing economies to international trade were also remarkable and have been increasing steadily with a growth speed that is almost double that of developed economies. Total

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new consumption of emerging and developing economies also exceeded that of developed economies, and emerging and developing economies became the main driver of consumption growth. In 2011, the growth in goods and services consumption of emerging and developing economies were estimated to be 1.7 trillion US dollars more than the previous year, and this rapid growth will naturally increase the importance of emerging and developing economies in the global economy. In purchasing power parity (PPP) terms, emerging and developing economic bodies accounted for 47.8 percent of the global economy in 2010, becoming the dominant force in global economic growth for the first time. We expect that the “dual-speed recovery” of developed economies and emerging and developing economies to continue and it will develop into “dual-speed growth” to further reinforce the current momentum of emerging economies’ lead in the global economic growth (see Figure 9.1). The overall macroeconomic outlook for emerging and developing economies is more optimistic: the relatively low budget deficit, manageable public debt, stable banking system, low level of cyclical unemployment, and strong growth momentum. In contrast, many developed economies are facing serious challenges, such as severe fiscal deficit, huge public debt, serious problems in the banking systems, high levels of unemployment, and sluggish growth. In addition, the recent structural adjustments of emerging and developing economies have strongly supported the three key factors of economic growth: rapid growth of the labor force and continued urbanization of the population, increased in investments that come with steady inflows of foreign capital, and rising productivity through the upgrade of the value chain of their industries. If the current momentum can continue for the next 20 years, global economic output will increase from 78 trillion to 176 trillion US dollars at current prices, of which 61 trillion US dollars of growth will come from emerging and developing economies while developed economies will only contribute about 37 trillion US dollars. The “dual-speed recovery” of developed economies and emerging and developing economies during the crisis, the current “dual-speed growth” as well as the likely “dual-speed growth” in the future has changed the global economy and these aspects will continue to transform it greatly. II. Ongoing Profound Changes in Global Economy The center of global economic growth is shifting from developed economies to emerging and developing economies, and this caused important structural changes in all aspects of the global economy.

structural changes of global economy

Percentage of Global GDP (Based on PPP)



159

70

60 50

40 30

Developed economies

20

Emerging and developing economies

10 0 1996

2001

2006

2011

2016

Year Source: IMF, IMF, World Source: World Economic Economic Outlook OutlookDatabase Database.

Figure 9.1. Structural Change of Global Economy

1. Emerging Economies Are the Main Driver of Global Economic Growth and Demand The rise of emerging and developing economies into the leading force of global economic growth and demand is a historical change. For the past 20 years, emerging and developing economies continued to grow at a faster pace than developed economies, but due to the smaller overall scale of emerging and developing economies, developed economies continued to be the main contributor to global economic growth. When the two types of economies are of a relatively similar size, however, the faster pace of economic growth of the emerging and developing economy will make it the main contributor to global economic growth, as well as the dominant force in global demand. The shift in the center of gravity for global economic growth also changed the population base of world economic growth. The total population in developed economies is roughly 1 billion, while emerging and developing economies have a population of roughly 5 billion, of which 3 billion are from emerging economies alone. As economic growth shifts into emerging economies, a higher economic growth will be spurred and a rising consumption demand will be created based on a population of 3 billion. This impact on the global economy is completely different from that of the slower economic growth and lower consumption demand

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based on 1 billion people. This change in population size and the increase in total consumption and consumption quality that comes with raises in economic growth and per-capita income is a dynamic process that is ever developing and adjusting structurally. The continuous increase of per-capita income and consumption structure of the 3 billion people in emerging economies will drive the future demand growth and structure of the global economy and will have a far-reaching impact on it in the future. 2. Total Global Resource Demand and Its Structure Are Experiencing Structural Changes People in emerging economies desire better houses, improved transportations, and a higher quality of life. This desire turned into a huge demand for non-renewable resources, such as oil and metals, and is fundamentally changing the total quantity and structure of global resource demand. Structural changes are more significant than quantity changes, and emerging economies are increasingly dominating the demand for global resources. In the past 10 years, global crude oil consumption increased by 13.5 percent, and consumption in emerging economies increased by 39 percent, while its share of global oil consumption increased from one-third to onehalf. Our estimate is that global oil consumption will be 34.6 billion barrels in 2015, of which 16.2 billion barrels will be consumed in developed economies and 17.8 billion in emerging economies. During the 15 years between 2000 and 2015, the structure of oil consumption has changed significantly. The demand for oil by developed economies decreased by 5.3 percent while demand for oil by emerging economies increased by 61.8 percent (Table 9.4). Table 9.4. Global Petroleum Consumption Global 2000 2010 2015 2000–2010 Annual Increase 2010–2015 Annual Increase (Estimated)

Developed Economies

Emerging Economies

28.1 billion barrels 17.1 billion barrels 11 billion barrels 31.9 billion barrels 16.5 billion barrels 15.3 billion barrels 34.6 billion barrels 16.2 billion barrels 17.8 billion barrels 13.5% –3.5% 39.1% 8.5%

–1.8%

16.3%



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Table 9.5. Global Copper Consumption Global 2000 2010 2015 2000–2010 Annual Increase 2010–2015 Annual Increase (Estimated)

15.8 million tons 19.5 million tons 33.8 million tons 23.4% 73%

Developed Economies 10.4 million tons 7.6 million tons 8.3 million tons –27% 9%

Emerging Economies 4.7 million tons 11.9 million tons 25.4 million tons 153% 113%

In addition, over the past few years, almost all of the increase in demand for copper, lead, nickel, tin, zinc, and other metals was from emerging economies. For example, the global consumption of copper in 2000 was 15.8 million tons, of which consumption from developed economies was 10.4 million tons and consumption from emerging economies was 4.7 million tons. In 2010, global consumption of copper increased by 23.4 percent from the year of 2000, and consumption from emerging economies increased by 153 percent. We estimate that in 2015, global consumption of copper will be 33.8 million tons, a 73 percent increase from 2010, of which consumption by developed economies will be 8.3 million tons, a slight increase of 9 percent; consumption of emerging economies will be 25.4 million tons, resulting in an increase of 113 percent. During the 15 years from 2000 to 2015, global consumption of copper more than doubled; the share of emerging economies in global copper consumption will rise from less than one-third in 2000 to three-quarters in 2015 (Table 9.5). The global demand for raw materials and other commodities and changes in energy consumption structure are driven by three factors. The first factor is the globalization of the manufacturing sector. For the past 15 years, the manufacturing sector, especially the labor-intensive element manufacturing sectors, experienced large-scale shifts from developed economies to emerging economies; these shifts caused increasing demands for raw materials, bulk commodities, and energies in emerging economies. These demands in emerging economies are a result of the globalization of the manufacturing sector. As a result of this, the regional demand structure changed, and, in turn, relative to the total output before the change the increased or additional total demand was fairly insignificant. The second factor is that as labor-intensive manufacturing sectors shifted from developed economies to emerging economies, the ­emerging

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economies correspondingly engaged in massive infrastructure investments that strengthened their growth, and internally increased their demand for raw materials, other bulk commodities, and energy. Relative to its original aggregate output, total new or additional demand started to change, shifting the demand curve outwards. The third factor is that as the population base for global economic growth changes and per-capita income for emerging economies steadily increases, it has created largescale consumption demand and the demand for consumption upgrade have been created. This new consumption wave drives the demand for raw materials, bulk commodities, and energy. For the past 10 to 15 years, global demand for resources has come mainly from the first and second factors, namely the globalization of the manufacturing sector and the large-scale infrastructure investments in emerging economies. Currently, the world is entering the third stage of increasing demand led by the increase in consumption by people in emerging economies. This change will start on a large scale in the future. 3. Global Agricultural and Food Processing Sectors Face Scale and Structural Adjustments As the per-capita income of large populations in emerging economies rises, people have the ability to consume more food and purchase more nutritious food. This increased the total demand for global agricultural products and food as well as changed the structure of the demand. To be more specific, the demand increased for basic food items, high-valued food items, and processed foods with nutrition supplements. In the past 10 years, people in emerging economies consumed more grains and their consumptions of meat, eggs, vegetables, and fruits rose significantly. Consequently, the increased consumption of meat and eggs also drove up the demand for beans and other products for animal feed, and this changed the demand structure for food. All of these have also created the need for pesticides, agricultural machinery, diesel oil, and electricity for agricultural use. This led to the birth of the large-scale modern food processing industry. Total new demand for food and the structural changes will lead to a new round of structural adjustments in global agricultural and food processing industries. During the current economic crisis, the prices of global resource commodities, such as minerals, metals, energy, and food, did not remain low after the crisis. Unlike the past few economic crises, they quickly rebounded. The main reason for this is the shifting of the global ­economy’s



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center of gravity to emerging economies. Agricultural products have a relatively inelastic supply that is largely influenced by the weather. This, with ample global liquidity after the crisis and abundance of speculative activities, resulted in 2010 being the year with the greatest price increase in global resource products in the past 50 years. The global food prices increased 28 percent, reaching the highest level in 2008 before the crisis. In the three quarters from the second half of 2010 to the first quarter of 2011, the food price index continued to rise by 44 percent. The price of grains among them increased by 85 percent in this period and exceeded the price level during the food crisis in 2008. The price fluctuations of agricultural products in the past few years gave clues to new trends in agriculture and the food processing industry. The shift of the center of gravity of the global economy towards emerging economies will further accelerate this process. 4. Realignment of Global Manufacturing Model The global manufacturing model is changing. After 20 years of the globalization of manufacturing, the world basically formed the following division of labor model: First, developed economies will produce capital and technology-intensive machinery and equipment as well as core mechanical and electrical components. Then, emerging economies will then import these sets of machinery and equipment to make labor-intensive and low-tech manufactured products, or to import the core mechanical and electronic parts to assemble into more high-tech products. This model of global manufacturing makes developed economies as the main driver of growth and the main source of consumption; the population of 1 billion in developed economies produces capital, technology-intensive, high-end products, and the more technologically advanced core electronic components then trades with the population of 3 billion in emerging economies for more low-tech and labor-intensive manufactured goods. As the center of gravity for global economic growth shifts from developed economies towards developing and emerging economies due to the sharp increase in the population base and the growth in per-capita income in the emerging economies, the original capital and technology-intensive manufacturing machinery used by developed economies and the production lines for core electronic and machine components are no longer able to meet the global total demand in a world where growth and source of consumption are led by emerging economies. Therefore, we will soon observe the large-scale entrance of emerging economies into the ­capital-intensive

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and technology-intensive machinery and equipment manufacturing sectors. Emerging economies will utilize their market advantages to research and develop core mechanical and electronic components, actively move up the value chain of manufactured goods, and to a certain extent realize the self-reliance of the global manufacturing industry in the emerging economies. In the meantime, they will shift the production of low-tech manufactured goods towards low-income economies. In the past three years, this phenomenon has gradually become apparent in parts of the emerging economies, and this process will push developed economies towards more high-end technological developments and more innovative service industries. We have observed the emergence of more advanced high-end precision electronics, manufacturing, and high-tech innovation industries in some developed economies. 5. Appearance of New Global Trading Structure Led by South-South Due to the rise in the population base and per-capita income, domestic demand in emerging economies will increase greatly as it is becoming the net demand side of the global economy. In 2010, the growth of total demand in Asian emerging economies exceeded the growth in total productions while developed economies as a whole, including the United States, European Union, and Japan, had total demand growth less than their total production growth. Gradually, emerging economies will become the dominant force in global demand, and the main importer of the world. The current account in balance of payments will also undergo a fundamental and directional change; emerging economies will become the main import/exporter of the world in the future and a leading force that drives the growth of global trade. It will push the global trade into a new stage of development and will help to set new rules for global trade. The structure of international trade flows is also undergoing changes. Due to the significant growth in both its production and domestic consumption, emerging economies will increase their trades with developed economies. At the same time, trades between emerging economies and low-income economies will also expand. For the past 15 years, economic globalization and free trade existed mainly between developed economies and emerging economies. Trade growth between emerging economies and developing economies, especially low-income economies, is still lacking. This situation began to change in the past five years within emerging and developing economies. We especially noticed significant acceleration in trade growth between emerging and developing



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e­ conomies and ­low-income nations. Emerging economies are gradually becoming the driving force for economic growth in low-income nations. For example, in 2010, the export by the Brazil, Russia, India, and China (BRIC) trading bloc to low-income countries reached 50 percent of the amount exported by developed countries. Under the framework of the WTO, the tariff between developed economies and emerging economies has been lowered to recognized international standards. On the other hand, there is still much room for adjustment for the tariff between emerging and developing economies, especially low-income countries. The dominance of the South-North trade model in the past 15 years is shifting to a dual trade model of South-North and South-South. 6. Profound Changes to Global Capital Flow and Financial Structure As the center of gravity for the global economy shifts from developed economies to emerging and developing economies, the most important changes are the large global capital flow and the tremendous change in financial structure. When developed economies and emerging economies have their equal shares of the global economy calculated by PPP, the financial strength of emerging economies still lags behind developed economies. In 2010, emerging economies held only 19 percent of the world’s financial assets. Since the nature of capital is to pursue economic growth and opportunities for return, global assets will flow to emerging economies, and this will lead to the restructuring of the world’s financial assets and the financial industry. A new phenomenon that occurred after the last financial crisis is that emerging economies have not only displayed its great strength in economic growth, but they have also shown a more stable macroeconomic environment. From the current macroeconomic point of view, for the first time in recent history, we see relatively high financial debts, high fiscal deficits, high government debts, high unemployment, and weak economic growth in developed economies. Conversely, emerging economies face relatively low financial liabilities, low fiscal deficits, low government debts, low unemployment, and stronger economic growth. Developed economies have lower interest rates compared with emerging economies. The credit ratings for developed economies and emerging economies will also undergo some drastic changes. As of the date of this paper, few emerging economies have higher ratings on their sovereign debts than those of developed economies. All of these demonstrate favorable macroeconomic conditions for the transfer of capital from developed economies to emerging economies.

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In the new round of global capital flow, long-term financial investment capital will play the key role. During the last 15 years, global capital flow accelerated with economic globalization first by accompanying manufacturing globalization with large-scale foreign direct investment from developed economies to emerging economies. Later, following the trend of financial globalization, capital with a high liquidity need began to flow from developed economies to emerging economies. After the 1998 Asian financial crisis, private capital flow from developed economies to emerging economies began exceeding official capital flows, and it became the main source of global capital flow. In the foreseeable future, capital from asset allocators, such as pension funds, mutual funds, annuities, and private equity funds, will flow from developed economies to emerging economies on a much larger scale. These funds hold and invest the majority of financial assets in developed economies and their financial sizes are huge. If one percent of the current financial assets of developed economies flowed to emerging economies, it would represent more than the yearly amount of foreign direct investment (FDI) flowing from developed countries to emerging countries. For example, we have observed that capital flow from the United States to emerging markets increased from an average of 300 billion US dollars between 2006 and 2007 to approximately 550 billion US dollars in 2010, and its capital flow to developed economies decreased from an average of 900 billion US dollars from 2006 to 2007 to around 600 billion US dollars in 2010. International capital flow into Brazil alone reached 100 billion US dollars in 2010. When there are large-scale capital flows from developed economies to emerging economies, financial institutions of developed economies will also utilize their scale, global network, and trade platforms plus products and technology advantages to once again enter emerging economies on a large scale. III. Challenges and Reforms of Emerging Economies The center of gravity for global economic growth is shifting, and this may help emerging economies to close their gaps in total economic output and per-capita income with that of developed economies. This shift will also help millions of low-income people overcome poverty and improve the overall economic growth in the world and could be an important milestone for the development of human society as a whole. Now, maintaining the sustainable growth of emerging economies is the greatest challenge for the whole world. The shift in global economic growth also poses a



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series of new challenges for emerging economies. Although emerging economies are currently growing steadily, past experiences show that they will soon face the necessity to undertake fundamental structural changes. Their sustainable growth will not occur automatically. Only through indepth structural reforms of their growth models, policies, lifestyles, and other areas are emerging economies able to meet their short-term as well as mid-to-long-term challenges ahead. 1. Changing Growth Model from External Demand-Pull to Internal Supply-Push As the global economic center of gravity shifts to emerging economies, a growth model dependent on demand from developed economies is no longer suitable for their growth of emerging economies. Emerging economies should shift their development focus from export-oriented growth to a domestic supply-led growth. New policies should also be implemented with special emphasis on the supply side. Change in the growth model will be the most important challenge faced by emerging economies. In the past 15 years, emerging economies basically adopted the exportled model of economic development. External demand led by developed economies plays the dual role of not only stimulating demand-pull but also of changing the domestic economic structure. Economic growth in emerging economies and related economic structural changes mainly depend on changes in external demand. The first change is the transfer of labor from rural areas to urban areas from non-trade sectors into trade sectors. Then comes the adjustments to domestic industrial structures based on changes in external demand. Presently, economic growth in developed economies is decelerating; as mature economies, the developed economies have little need for structural changes. Therefore, the external demand-pull by developed economies on emerging economies has been less effective for the past decade, and its influence on internal economic structures for emerging economies also decreased greatly. Even before the financial crisis, there were many discussions regarding the need for emerging economies to change from an export-oriented growth model to a domestic demand-led growth model with an emphasis on using internal consumption demand to replace external export demand. During the 2008 global financial crisis, emerging economies experienced a decrease in external demand from developed economies. Therefore, governments pushed for large-scale fiscal stimulus packages through largescale infrastructure investments, social and cultural ­programs, and direct

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subsidies to residents to increase domestic demand to take the place of the decreased external demand. These policies achieved very good results. With their governments’ proactive fiscal spending, emerging economies rebounded quickly and their economic growth has been maintained. However, further analysis indicates that the economic growth of emerging economies for the past few years is mainly the result of the replacement of decreasing external demand with an increase in huge domestic investment demand, not from the increase in domestic consumption. History shows that economic growth driven by investment demand alone is unsustainable. For the same reason, domestic demand created by large-scale government fiscal stimulus policy to fight economic crisis is not sustainable. Currently, emerging economies have basically spent all their fiscal ammunitions accumulated before the crisis. Total domestic demand-pull with more government fiscal stimulus will not be effective in adjusting domestic economic structure and pressure for inflation is beginning to appear. We have problems in our current economic growth model, which is driven mainly by domestic investment demand fueled by government fiscal stimulus policy. Purely domestic demand-led growth is still a concept of aggregate demand; if we are looking for long-term sustainable growth, the central question is where the total domestic demand comes from. Development economics shows us that the increase in internal demand is related to adjustments to the domestic economic structure, to income structure adjustment, and to per-capita income of a nation’s residents. Therefore, not only do emerging economies have to shift their reliance on government policies pushing aggregate demand from outside to more internal changes but they must also study how to make sustainable adjustments to their economic structures, move their whole economy up the value chain, increase value-added production, and increase productivity and per-capita income. The economic history of Japan and South Korea demonstrated that internal economic structural adjustments and improvements for emerging economies do not happen automatically; it requires the government to proactively formulate industrial policies as guidance. But the economic history of Japan and South Korea also shows that as governments set up industrial policies, they do also face the risk of policy mistakes. The most important challenge emerging economies face today is how to learn from history, from other countries, and from exploring to find the appropriate adjustment policy based on the unique characteristics of their domestic supply and practices. They need to build economic and industry structures with emphasis on the supply side and structures



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with mechanisms that are self-adjusting and highly adaptable to changes and innovations. They also need to build supply growth models to push for changes in economic structure and demand. These will be discussed in the following sections. 2. Strategic Advantages in the Changing Global Manufacturing Industry As mentioned earlier, the global economic center of gravity is shifting from developed economies to emerging economies, and this has lead to changes in the economic growth model as well as lifestyle changes. It has also triggered a wave of shortages of resources and rising costs. This will not only cause repositioning of the global manufacturing chains but it will also spur the demand for new products and new technology, which in turn will lead to a new demand for strategic emerging industries. Global competition for strategic manufacturing advantages and manufacturing repositioning has quietly begun. Developed economies are moving to more high-tech sectors. The first one is the resources sector. They are searching for the effective use of resources and energy, including new energy and more efficient, more environment-friendly use of traditional energy with new technology and new equipment. The second sector is the medical and healthcare industry, including new medical fields of gene therapy and organ transplants. The third sector is the IT sector, especially from the breakthroughs of cloud computing and Internet search technology, which have spurred tremendous changes in the communications, media, and service industries. The fourth sector is the research into artificial intelligence and the development of sophisticated robotics to revolutionize the entire manufacturing and service sectors. The fifth sector consists of more advanced and more high-tech, innovative products in the service industry. All of these will change the industrial structure in the future and will drive the growth of emerging industries. Emerging economies are moving up in a large scale into the value chain of manufacturing industry by making high-end precision instruments and high-end machinery, such as complete systems for mining, exploration, construction, and road works. They also manufacture high-end systems for railways, waterways, and petrochemical refineries. At the same time, they have entered the turf of developed economies dominated by hightech and innovations, such as new energy, new technology, and new equipment, that make traditional energy more efficient, more environmentally-friendly, and less polluting. They are also moving into brandnew IT sectors, mobile communications, and social media that were born

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with cloud computing as well as other high-tech innovations and services. Meanwhile, emerging economies are slowly moving their low-tech manufacturing and processing industries to low-income countries. The lowtech manufacturing industry grows quickly in low-income economies, and these economies are beginning to become the true producers of laborintensive manufactured goods in terms of scale. During this era of the global manufacturing industry transformation, shifting to high-end manufacturing, moving up the value chain of manufacturing, establishing strategic and competitive advantage, creating more value, and transferring low-tech manufacturing to low-income economies in a timely manner are the most important steps for emerging economies to become engaged in the new wave of global competition. The most important strategic task for emerging economies is the successful strategic transformation of their industries and income rise of their population. The key to the implementation of a domestic, demand-driven economic growth model is to shrink income gaps and improve income ­distribution. 3. Raise Agricultural Output, and Increase Agricultural and Food Processing Industries’ Labor Productivity Changes in the aggregate demand and structure of agricultural and food products driven by the shift of global economic growth is a long and ongoing process. The world has the ability and room to support the demand for agricultural and food products needed by its current population and for its economic growth, but it takes a long time for the agricultural product supply to adjust to demand because it is much affected by the weathers. Furthermore, with the rapid growth and spread of financial derivatives, agricultural products are increasing and becoming financial products tradable around the clock and around the world. This increased the fluctuation of agricultural supply. The consumer price index (CPI) for emerging economies usually has a larger proportion of food products. For example, food accounts for 58 percent of India’s CPI, 48 percent of the Philippine’s CPI, and 46 percent of Indonesia’s CPI. Due to the constant and rapid changes to the aggregate demand and structure of agricultural and food products, the time lag in adjustments, increased fluctuations caused by financial derivatives, and the high share of agricultural products in the CPI, it has become an increasingly important aspect of the macroeconomics of emerging economies, and we have to effectively manage agricultural and food products supply and demand. It is also the key to maintaining social stability and long-term economic growth for emerging economies.



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In the past few years, investments in the agricultural industry by emerging economies have been significantly less than investments in manufacturing industry. This means the government must increase investments in the agricultural industry, implement investment policies to support agriculture, promote agricultural research and technological advancements, improve innovations in the agricultural sector, and increase productivity. While the labor productivity of the manufacturing sector continued to steadily increase for the past 20 years, rises in productivity increase in the agricultural sector were relatively slower; this caused rapid rising prices in agricultural products when the global economic growth accelerates and the population structure for consumption changes. The soaring prices of agricultural products have become one of the key risks to social stability and continued economic growth. Structural changes in consumption demand are pushing the food processing industry into an important pillar industry and raised the bar for labor productivity in it as well as the need for the food processing industry to move up the value chain. With acceleration of global economic growth and changes in population structure for consumption, the agricultural and food processing industries have become strategic industries for emerging economies and requires the support of government policies. 4. Pay Special Attention to Service Industries Development economics theory and practice demonstrate that, for emerging economies, developing their service industries is the most important step to increase their per-capita income, decrease wage gaps, and implement domestic demand-pull economic growth. Service industries can steadily increase employment and raise population income. Especially because the service industry employs more labor, it will help low-income populations to increase their incomes. Only through the growth of the service industry can residents enjoy increased incomes and consumption. Because trade sectors are the first to benefit from globalization, the nontrade service sectors of emerging economies are already lagging behind. They will need increased government support for their growth. Developing the non-trade service sector requires a wide range of government policies. First, the government must open the market for the service sector and not over-protect various types of small businesses at the expense of consumers. The government also must try to break-up monopolies and remove entrance barriers to let more parties into the market to increase efficiency and reduce pricing pressure. The government then must set up regulations and policies, such as open, fair, and transparent regulatory

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standards, and effectively supervise the implementation to maintain fair competition and high service quality. Fair and transparent tax policies, healthcare, insurance, and a pension system based on individuals are also needed. The challenge for emerging economies is to grow their capitalintensive manufacturing industries, labor-intensive and technology-based service industries, and create innovative manufacturing and service industries simultaneously. If they can balance these three priorities well, the emerging economies can become an effective economic body with real growth. This also means increased investment by the governments in basic infrastructure, especially in transportation and energy. They have to guarantee the freedom for parties to enter and exit all markets so companies can seize business opportunities. Meanwhile, this also means more social infrastructure investments by the government, including better quality of education, on-the-job training for workers, increased efficiency of capital, and raising household income. More investment in existing and new technology applications will also help increase productivity. 5. Accelerate Fiscal Reforms and Build Social Security Systems As populations grow, many emerging economies are faced with inadequate social pension and healthcare systems, further burdening our future generations. Emerging economies must immediately construct more viable social pension and healthcare systems and must also further implement reforms and broaden coverage for high-quality healthcare. Current governments of emerging economies do not have heavy debt burdens and have relatively young populations and relatively fast economic growth. This gives them the perfect opportunity to establish, reform, and develop social pension and healthcare systems now. Establishment of pension and healthcare systems will also increase the transparency of government debt and this will help the overall macroeconomic and fiscal management. Based on existing statistics, we see that emerging economies have a fast-aging population with a rising life expectancy, but their average accumulated wealth is relatively small. Immediate establishment and development of social pension and healthcare systems is an important strategic objective for emerging economies in order to experience sustainable long-term growth. Experiences from other countries show that developed economies have both successes and failures in the reforms of their pension and healthcare systems. Emerging economies should learn from their experiences and take advantage of the current surge of economic



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growth and their relatively good fiscal situations to quickly design and implement suitable social security systems for themselves. 6. Accelerate Financial Reforms to Prevent Financial Risks As the center of gravity for the global economy shifts, changes in global financial structure are inevitable. Large amounts of capital flowing into emerging economies create an opportunity as well as a challenge for them. Overall, foreign financial capital inflow has many benefits: It can increase cash liquidity and improve technology and management for traditional manufacturing industries; it can also expand and accelerate emerging economies’ much-needed investments in basic infrastructure; furthermore, it will provide much needed capital for education, medicine, and other social sectors; finally, it will benefit the development of a financial market with long-term capital, and it will help to expand and improve the financial market. On the other hand, foreign capital inflow will raise consumer goods and asset prices; it will especially exacerbate the real estate bubble and increase overall risk in the financial industry. As financial markets of emerging economies are still evolving with limited scale and depth, large waves of speculative foreign capital inflow can easily create shocks to local financial markets, especially during periods of violent fluctuation of capital inflow, pauses, and outflow. This can easily cause financial market turbulence and even crises. We are currently seeing large capital inflow into emerging economies and this will continue on a larger scale in the foreseeable future. Immediate reform of their financial systems should be the top priority for all emerging economies. Finance is the center of all economic activities. It transfers a nation’s savings into investments and it is a key factor for economic growth. As large international capital flows in, financial institutions play an important role in directing it into effective domestic sectors. Growth opportunities in emerging economies will attract large amounts of long-term capital inflow; under proper guidance, they will not only benefit the real economy, but they will also improve the financial sector. The latest financial crisis has demonstrated that emerging economies need large-scale financial reform in these areas: (1) follow free-market principles and encourage market competition; (2) set clear rules on how to enter and exit financial markets; (3) establish effective financial supervision and regulatory systems; (4) build prudent macroeconomic management mechanisms; (5) strengthen corporate governance and increase ­transparency. Emerging economies must also establish basic

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financial market ­infrastructures, such as clearing houses and settlement and payment system and also procedures for bankruptcy and liquidation. Another important lesson we have learned from the last financial crisis is that reforming financial systems must ensure that the job of financial institutions is to serve the real economy, not the other way around. Financial reforms have to be coordinated globally. 7. Construct Macroeconomic Financial Regulatory Framework to Ensure Stability Global economic growth led by emerging economies also created new challenges to macroeconomic financial regulation, and experiences show that there are many fluctuations in the economic and trade growth of emerging countries. As emerging economies become the dominant force in the global economy and trade, they will also increase the fluctuation of global economic growth and trade; as a result, the fluctuation will decrease income and employment stability. Emerging economies themselves face fundamental structural adjustments but changing their growth model is not an easy process. As emerging economies increasingly become the driving force of global economic growth, conflicts between developed economies and emerging economies will increase and the trade frictions between the two types of economies will become more frequent. Therefore, emerging economies need to further strengthen and construct their macroeconomic financial regulatory framework, including coordination of their currency policies, fiscal policies, and prudent macroeconomic policies by establishing and coordinating effective financial supervisory and crisis management systems. They also need to construct fiscal and financial buffer zones and implement sound macroeconomic and fiscal policies. At this moment, emerging economies must pay special attention to warning signs of an overheating or bubble economy. They need to control inflation and use macroeconomic tools to mitigate capital market volatility and liquidity issues. In the meantime, emerging markets must continue to improve their structures and refine their systems and enhance their ability to implement relevant policies. 8. Balance Economic Growth, Employment, and Income Distribution to Maintain Social Stability The global financial crisis exposed imbalances in global economic growth, employment, and income distribution over the past several years. Economic growth was too concentrated in certain sectors. Poor employment,



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particularly among the youth, growing disconnection between what is taught in schools and what is needed in the real world, and the widening gap of income distribution are all increasingly becoming a global phenomenon. Maintaining efficiency and fairness has always been the focus of the market and the role of the government and this issue has new characteristics with increased globalization. Economic and financial globalization broadened the market place, spread the use of technology, lowered costs, and enhanced management efficiency. Labor productivity increased rapidly in sectors relevant to globalization and much more slowly in less globalized sectors. Therefore, in a market economy, income distribution initially moved toward trade sectors and employment, but due to global competition in trade sectors and increased labor productivity, it shifted toward non-trade sectors. This created an imbalance between economic growth and employment as well as an imbalance in the structure of income distribution. Traditionally, people are inclined to develop trade sectors first. As trade sectors are developed and wealth is accumulated, they then turn around and develop non-trade sectors. However, experiences with globalization demonstrate that under the effect of globalization, the speed and scale of trade sector growth are much faster and bigger than before, and if we turn around to develop non-trade sectors after trade sectors become well-developed, there’s already a large gap with problems difficult to solve. Thus, under globalization, government intervention to coordinate economic growth, employment, and income distribution becomes especially important. When the trade sectors are growing relatively faster, especially when they are the leading industry for economic growth, the government needs to implement relevant employment and income distribution policies in advance. These policies include labor market reforms, free movement of labor, increasing support for non-trade sectors, working to improve labor productivity in non-trade sectors, raising the level of basic education so students can meet the employment requirements of trade sectors after graduating, and increasing labor training so workers can adapt quickly to the demands of trade sectors when they need to move from non-trade sectors. The governments also need to have policies to provide aid and relief to the weakest groups of society. .

9. Searching for a New Way of Life Important challenges to the emerging markets also include teaching people how to respect the earth and its limited resources and how to create a new way of life. With the changes in growth structure, the 3 billion people

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in emerging economies cannot have and maintain the current lifestyle of one billion people in developed economies. Economic crisis taught us that the borrow-to-spend lifestyle and economic growth model of some developed countries are not sustainable. Emerging economies and the world as a whole have the mutual responsibility to search for suitable lifestyles and economic growth models, and we have to care for our future generations. We need to thoroughly consider these issues as growth models drive economic progress and lifestyle drives growth models. This is an important and fundamental issue. We need to have a lifestyle that uses fewer natural resources and that is more environmentally friendly. We need to maintain a more harmonious existence between humans and our environment. Governments can create reasonable incentives through fair pricing of carbon, including environmental costs in national accounts and the true value of the ecosystem in their national wealth calculations as well as promoting conservation, efficient use of energy, and the production of clean energy. We also need to pay closer attention to consumer products and spending habits, adjust these habits, and formulate a new lifestyle. 10. Actively Participate in International Affairs and Cooperate to Setup New International Rules The rise of emerging economies to become the center of gravity for the global economy is a major economic and political event in this century for the human race. Because of changes in the structure of the world population, growth models, and the speed at which things happen as well as changes in lifestyles, the emerging economies will push for constant reforms and the development of new global economic and trade rules in the process of driving global economic and trade growth. Most international rules that exist today are based on and set for the growth of developed economies. Developed economies established most of the frameworks for international governance organizations. Because global economic situations changed, there must be new international rules to govern the economy. For example, some steps that should occur are the following: (1) There must be discussion and confirmation of new economic and trade growth situations as emerging economies become the center of gravity for the global economy and trade; (2) exploration and explanation of new ways for life for the human race; (3) increased interdependence of economies and finances of various countries with globalization; (4) recognition of the spillover effect of each country’s own macroeconomic and



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fiscal policies, new ideas for international economic and financial cooperation, and the institutional framework of global economic and financial governance. The world financial crisis in 2008 showed us the failure of traditional market theory, traditional governance, and government policies. Criticism of traditional theories will lead to the exploration of new frameworks of macroeconomic and financial theories. The world needs emerging economies to actively participate in these international affairs and emerging economies will have fresh experiences in making contributions to new international rules and regulations. Emerging economies also need these new international rules and regulations to protect themselves and continue their sustainable growth under the new global governance mechanism. The world is changing, and the future is still uncertain. For emerging and developing economies, the past two years have been good and the future seems optimistic. However, we cannot guarantee that such a wonderful time will last. As a matter of fact, if the aforementioned issues do not receive enough attention and reasonable solutions cannot be found, our beautiful tomorrow will likely be gone with the wind. Our modern history is littered with thought-provoking cases of lost years or even lost decades due to policy paralysis.

Part three

Chinese National Security

CHAPTER TEN

Chinese National Security: Its Missions, Sequences, and Major Characteristics Wang Yizhou* Abstract: Today and in the foreseeable future, we are, and will be, in the era of the peaceful rise of China. Responding to strategic frictions among major nations, handling the Taiwan issue and domestic separatism, resolving various sovereignty disputes involving China property, protecting growing Chinese interests overseas, and assuming appropriate responsibility for world peace and security, these are not only five major tasks we face for Chinese national defense and army building in this new era, but also important missions of our diplomatic endeavor and Chinese foreign relations. To meet these challenges and solve these problems, we not only need military involvement, but we also have to establish new concepts and institutional arrangements with wide social participation and better coordination among various groups. To better safeguard Chinese national security in this era of peaceful rise, we must adjust the functions of different branches of our government and balance the two important areas of international and national interests. We also have to gain greater understanding from the public. The key to realize our above missions is to overstep the narrow interpretation and framework of military struggles and see Chinese national security from a broader view as it emerges as a new power in the world. Keywords: Peaceful rise, Chinese national security, Chinese foreign relations

On the threshold of the second decade of the twenty-first century, China has become an emerging power accepted by the whole world. Just as with its economic, trade, finance, social, and cultural aspects, China has clear objectives in its military and national defense characteristics. It has and will continue to have a major influence on world peace and stability. This essay will evaluate the major missions of Chinese national security built upon today’s peaceful rise of China and stability of the world while explaining the implications and characteristics. The emphasis of this article is on showing the combination of China’s security needs and * The Chinese version of this article was first published in Guoji jingji pinglun 国际经 济评论 [International Economic Review], 3 (2012). Wang Yizhou is Professor and Associate Dean of the School of International Relations at Peking University as well as the Vice Chairman of China National Association for International Studies. His email address is [email protected].

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i­ dentifying key indicators and points without discussing all areas related to national ­security and listing all relevant debates and proofs. It is necessary to point out that there is not full agreement on this subject among Chinese scholars, think tanks, and the government. What is expressed here in this article is one of many opinions. I. Response to Conflicts among Major Countries For China’s decision makers, the end of the Cold War is an important frame of reference for measuring China’s security relationship, and setting up a realistic security strategy to prevent possible conflicts in future. The disintegration of the Soviet Union and the Gulf War in the late 1980s and early 1990s were major events, and they marked a new stage of international political and security evolution. No matter what local wars waged and what regional hot spots appeared, the end of the Cold War and the events of the Gulf War defined the basic characteristics of international relations. The United States became the single superpower, and a pyramid power structure gradually formed displaying this one superpower with many other powers. The unified global market, trades, and population migrations became important issues for all governments and the probability of large-scale conflicts among major countries were greatly reduced. This benefits China from the Chinese national security point of view because it happened at a time when China’s reform and opening-up entered a new stage. This safe international background helped China quicken its domestic modernization steps without the risks of major wars and worries of foreign invasion. In this sense, this period of strategic opportunities had little to do with the outside world; it meant a special opportunity for the growth of China as it provided the best chance for its domestic economic development and reform. At least for now, the biggest threat to Chinese security does not come from a certain country or group of countries outside, it comes from the slowing down or even stagnation of its own internal growth that cause serious social and economic ­problems. Let us look at areas of conflict among major countries. While keeping contact and communication open, the United States has not given up the prevention and containment policy in its relationship with China. On the Taiwan issue, the United States is the main obstacle for China’s unification. The United States is the biggest umbrella under which various Taiwan independent forces seek protection. It should be noted that at present conflicts with the Muslim world trouble the United States. Enemies such as al-Qaeda and tough opponents such as Iran’s President Mahmoud Ahmadinejad



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pose a threat to American soil and its worldwide interests. At this moment, the United States does not have time to interfere in other countries’ affairs without full consideration of benefits and risks involved educes China’s security pressure in East Asia and its neighborhood. Japan always has grave concerns about the rise of China and Japan’s main method in recent years is prevention. Because various sovereignty disputes with Japan will not be solved in the near future, China has to consider and take precautions against possible militarization. Overall, the probability of military confrontations between China and Japan is small and is further reduced by deep trade ties and travel by people between these two countries. Diplomatic efforts by both countries are another aspect that minimizes military conflict. With regard to Russia and India there are some issues such as illegal immigration and border disputes, but there are political dialogues and a positive attitude for cooperation. The common interests among these countries are greater than the need for dispute. There is not a major hidden danger of security conflict in China’s relationship with other major countries in the region including Europe. The probability of China being dragged into other possible regional military conflicts is close to zero. II. Handling the Taiwan Issue and Other Separatism Tendencies Since the end of the Cold War and into the foreseeable future, the Taiwan issue and other separatist forces in Xinjiang, Tibet, and other places have become and will remain important factors and constraints on China’s national security. China has military, diplomatic, domestic policy, economic, and political tools to respond to and resolve them; however, all of them are very complicated and have far reaching effects. Looking carefully at various potential hotspots of conflict, the conclusion is that these problems can easily drag China into a war whirlpool and lead to direct military confrontation between China and the United States. Handling the Taiwan issue properly will also have a warning effect to various separatist forces making trouble around China’s borders. Determining the proper strategy for the Taiwan issue and responding to other separatist forces will be an important test for the peaceful rise of China and become a key step if China is to play a greater role in keeping regional peace in East Asia. There have been numerous causes of turmoil in Russia and its neighboring countries for the last 10 years. One of the main issues is the growth and spread of ethnic separatism, which is implacable. Upon the establishment of the Soviet regime, Lenin had some important ideas on how to handle ethnic disputes left over from Tsarist Russia. Though Soviet ­leaders

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later made small mistakes in handling its domestic ethnic disputes, there were not big problems during the age of the Soviet Union. Crisis and problems in Russia after 1990 have much to do with the strategic errors that ­Gorbachev and Yeltsin made during the disintegration of the Soviet Union. Once Pandora’s Box was opened, it became impossible to put back all the devils. No matter how hard Putin tried, ethnic separatism became a major obstacle in the process of Russia’s revival, a main threat to Russian national security, and a significant factor restricting Russian military capability. Furthermore, from a global perspective the new school of extreme nationalism, separatism, and racism that emerged from the late 1990s is a result of the shock wave that came from the dissolution of the Soviet Union and East Europe. China should learn a serious lesson from Russia. The Taiwan issue and other separatist factors are a Pandora’s Box facing China’s decision makers. It is well known that the vast family of the Chinese nation comes from different regions, different cultures, and different nationalities. Since the birth of the new China and especially after the process of reform and openingup, great progress has been made in domestic national unity. But at the same time, there are some major hidden risks, such as the growing socioeconomic, cultural, and technology gaps between people living in border areas with people of the mainland, plus the existence of a few domestic separatist forces such as Tibetan Separatism, East Turkistan separatism, and the Mongolian independence movement with their ­foreign allies. There is a darkening shadow of conflicts among civilizations in today’s world since the end of the Cold War, especially after the ­September 11, 2001 events. If China lets Taiwanese separatist forces get what they want, it would not only cause regional instability and military confrontations between China and other related countries, it would also lead to a colossal disaster in China. Most likely, the disintegration syndrome of the former Soviet Union would appear in certain Chinese regions where many ethnic groups live together. If that were to occur, not only would all of China’s efforts for domestic national harmony have been for naught, but there also could be possible civil wars inside China and the nation would face the grave danger of falling apart. No matter what happens, Chinese political leaders and the Chinese military will take a hard stand against Taiwanese separatist forces. Only in this way can China safeguard its security and keep East Asian regions stable. This is the red line China draws for peaceful development and friendly relationship with its neighbors. Without wavering from this red line, China should carefully and closely study the complexity of the aspects regarding the Taiwan issue and the



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ethnic problems of Xinjiang and Tibet. First of all from the military point of view, not only is there a gap between the military strength of China and that of the few Western countries that stand in the way of China’s unification with Taiwan, but China also does not have an overwhelming military power against Taiwan. Even though closing this gap takes time, do not expect that China will not take military action against unchecked instigations from the Taiwanese independence movement in the future. One of the major goals of China’s national defense build-up is to close this difficult gap. Secondly, for Chinese decision makers the Taiwan issue is not only an inherited hot potato but it is also a challenge in post-World War II international relations and diplomacy. Its multi-level influences and complexity surpass any general problems. Domestically, the government has to balance military desire, diplomatic need, business interests, and public opinion. Internationally, China has to deal with hardline forces in the United States and Japan that support Taiwan. In addition, China has to educate its neighboring countries about its policy and goals toward Taiwan. Thirdly, the ultimate solution to the Taiwan issue may be different from the way Hong Kong returned to China. Hong Kong was taken back from a Western colonial power, while a non-communist Chinese government has ruled Taiwan since the end of World War II. This fact requires that Chinese decision makers and their think tanks take careful consideration of the will of the Taiwanese people, look at Taiwan’s social and economic growth and experiences of the past half-century, and study the progress of Taiwan’s political structures of the past decade. While maintaining and expanding an effective deterrent, the Chinese political decision makers should take the cohesion and the ultimate unity of the two sides of the Taiwan Straits as a long-term process. Lastly, China must find the tool to deal with separatist forces in Xinjiang and Tibet. Some governments in South and Central Asia acquiesce and tolerate them, and this caused some difficulties for the Chinese government. China has to maintain good relationships with these countries and it has to think about how to implement its growth strategies for its western regions and related local policies regarding different ethnic groups. China cannot solve these problems with military and diplomatic tools. We need to coordinate both international and domestic priorities, set up strategy, and implement it carefully. III. Responding to Various Sovereignty Disputes Involving China Another important mission for Chinese national security during this peaceful rise of China is to deftly handle sovereignty disputes with its

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neighboring countries while rapidly building an effective military deterrent. This strategy will prevent deterioration of security situations around China will not slow our domestic modernization progress. Not only is China the world’s most populous country, it is also one of the countries with the largest territory. The China land mass is 9.6 million square kilometers and it also owns 3 million square kilometers of ocean, according to the United Nations Convention on the Law of the Sea. It is a fact of which few people in China are aware. As a large country, not only does China have very long land borders with 14 neighboring countries but it also has lengthy coastlines with another dozen neighbors by water such as Japan, South Korea, some Central Asian countries, and most Southeast Asian countries. It is quite rare in today’s world to have so many neighbors. This created various opportunities for China to make friends and it also presents a troublesome security dilemma. To defend its sovereignty, China faces more disputes and problems than most countries. In the past and even today, more than a dozen countries had and are having sovereignty disputes with China, including disputes about land borders, coastal waters, islands, bays, the continental shelf, and exclusive economic zones. Putting earlier conflicts aside, during this past half-­century China had military confrontations with India, Russia, and Vietnam, over disputes on borders and ocean rights. These confrontations had a negative impact on China’s domestic economic growth and social psychology. In the early days of new China, the government skillfully resolved the border disputes with Burma. After the end of the Cold War, China successfully settled a land dispute with Russia. China now has to resolve the conflicts with the Diaoyu Islands, a coastal border with Japan, some disputes with India on Kashmir over land borderlines, and various other disputes over water rights in the South China Sea with some Southeast Asian countries, such as The Philippines and Vietnam. On the surface, these sovereignty disputes are simple and should be discussed and resolved by two parties, but in reality, three or more parties are getting involved. For example, we always see the shadows of the United States in Sino-Japan disputes with the US-Japan Security Alliance acting as a virtual weapon of containment. There is the Taiwan issue in the dispute over the Diaoyu Islands and its waters. Fishermen of China, Taiwan and Japan are also involved. The sovereignty dispute between China and some Southeast Asian countries may lead to collective action defined by ASEAN. Among the 10 countries that have sovereignty disputes with China, some are capitalist countries with close economic and trade ties with China, which results in mutual dependency, some are ­developing



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nations who always stand by China’s side on human rights issues and other international disputes, and some are old comrades and comrades in arms whose political system and ideology are similar to that of China with there still being some warm memories between the people of the two countries. From the strategic point of view, there are unusually large military installations in the matters where Chinese sovereignty is concerned; for example, three out of the five permanent members of the UN Security Council, five out of eight countries which have nuclear weapons, and eight out of 12 with the most military power. In addition, many nations have long historical hatred and fights. Some examples are Japan and its East Asian neighboring countries, North and South Korea, India and Pakistan, and mainland China and Taiwan. There are also certain situations that may lead to new conflicts such as the rise of separatism, acts of hegemonies, imbalance of economic growth, and strategic misjudgments among nations. Combined together, these factors can easily lead to conflicts and even destroy regional peace if China doesn’t pay close attention to them. One of the primary missions of Chinese national security is to maintain the integrity of its territorial boundaries and defend its own interests in disputed areas. But empty slogans are useless in safeguarding national sovereignty in this new era and new environment, and new ideas and strategies are needed as well as detailed preparation. First, the modernization of China’s national defense system has to be highly adaptive to changes of objectives. Before the end of the Cold War, most sovereignty confrontations China was involved in occurred on land, with the major threats from the North (the Soviet Union) or the Southwest (India). Because of this, the Chinese army played the major role in defending borders with the Chinese navy and air forces as supporters. Today, sovereignty disputes over land are less frequent and threats on borders are greatly reduced. China negotiated and re-drew borders with Russia, Vietnam, Kazakhstan, and Kyrgyzstan. China is still negotiating with India on some border issues, but the Sino-India relationship is improving, and these two biggest “stars of hope” in the emerging economy do not want to see each other in military confrontation. So, in the foreseeable future, defending the borders will be more likely guarding the borders because the risk of large-scale military actions over borders is quite small. For this reason, the reduction of the Chinese army’s size is inevitable. However, sovereignty disputes over water are getting more frequent and serious with the threat of the Taiwan Straits; the militarization of Japan and its hardline attitude in its dispute with China over waters; emerging troubles in Northeast and Southeast Asian regions; and, finally, the

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only superpower on the other side of the ocean—the United States—with its far-reaching military capacity. It is clear that the emphasis of China’s national defense and its diplomacy are turning to the neighboring AsiaPacific region and especially its waters. With objective analysis, it is clear that to meet the goal of always being ready to win a regional war with high technology, the Chinese are building a modern military, especially a navy, air force and marines with high-tech weaponry, for all possible conflicts over waters in Southeast Asia. Besides its special secret weapons, China plans to build a fleet of far-reaching aircraft carriers and develop a related marine strategy. Guarding the land, the original duty of the Chinese military will have new meanings. In this regard, diplomatic effort has to be made as the first step toward smoothing relationships with countries in sovereignty disputes and gradually winning them over as China’s partners to build a new Asia. It should be specially pointed out that it is not just a soldier’s duty or the Defense Ministry’s job to maintain China’s territorial integrity and border sovereignty; it needs overall coordination with the various branches of government involved. The major goal in this period of strategic opportunities is to increase our nation’s development and growth, to implement various important domestic reforms, and to raise the living standards of our people. Research into sovereignty issues must have this important goal in mind. So, in this age of peaceful rise, when it is pertinent to research and to resolve sovereignty disputes related to China, following the “put dispute aside and work together” principle developed by Deng Xiaoping (邓小平), it is important to try to create harmony and stability in the border regions and settle various disputes peacefully. IV. Case Study: New Ideas to Break through the South China Sea Predicament The South China Sea issue is like a touchstone that can be used to test the progress of the peaceful rise of China and its ability and skill to co-exist harmoniously with its neighbors. From an international relations point of view, the South China Sea issue has the following importance and complexity: First, the South China Sea is the largest water in dispute on the globe. Many members of ASEAN have various sovereignty disputes with China over its islands, waters, continental shelves, and economic zones. For the past 10 years and since the establishment of the United Nations Convention on the Law of the Sea, there have been waves of “blue land



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grabs.” The fiercest battleground is the South China Sea. Second, in the past, all countries that claimed their sovereign authority came up with various reasons and proofs; all countries could find evidence of their claims on the South China Sea from their history. This resulted in the typical situation where every country is correct in its own way. Recently, all parties involved in the South China Sea sovereignty disputes submitted statements, proclamations, and border proposals to members of Convention on the Law of the Sea. It is not easy for the international society to render fair opinions, and usually an international tribunal is not able to make a quick and clear-cut judgment. Third, since the beginning of the new century, China gained more strength as a nation and its navy has moved beyond its coastal waters, these historical sovereignty disputes over the South China Sea have become more confusing, more complicated, and more dangerous. The Southeast Asian countries that have sovereignty claims over the South China Sea happen to have large populations of overseas Chinese who were strongly against China politically before and during the ­Cultural Revolution (1966–1976), a time in which there were many diplomatic frictions in this region. The rapid rise of China brought negative associations and reactions. The China threat theory, with versions such as China power politics and China maritime expansion, is getting popular in countries bordering the South China Sea. Fourth, under these circumstances, the United States, as the world’s police, certainly wants to get involved. The rapid economic and military growth of China has not only disrupted the Asia-Pacific region’s balance of power which was established and controlled by the United States, it also poses a threat to the safety and political interests of this superpower in Southeast Asia. Because of this, the United States has returned to Asia in a major way, with warnings to slow down China’s expansion and help Southeast Asian countries resist external pressures. Fifth, Chinese decision makers and the general public in China have not studied these complicated and unfavorable situations carefully and they are ill prepared to have any proper response. For example, even though Chinese scholars and people in relevant branches of China’s government agree that China should follow the principle of “put dispute aside and work together,” put forward by Deng Xiaoping they have a totally different understanding and explanation of this principle. China cannot even agree whether it should have talks involving two parties or multiple parties as to how to use China’s military and trade power, how to take advantage of its cultural influence, and its diplomatic experience to resolve the South China Sea dispute. China does not seem to be on the same ground as the

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military and the diplomats want to do things differently. There are opposing views even within the military. Local businesses and local governments also have different goals. Fishermen, offshore drilling companies, and even the maritime surveillance fleet have their own and different interests to seek and to protect. Some of their interests are similar, some are far apart. How to properly resolve the South China Sea dispute and how to manage this difficult situation will become an interesting case study to revealing whether China’s “creative involvement” diplomacy works in this new age and how effective it will be. In order to handle difficult issues in the South China Sea in the future, the Chinese government can employ an approach that is original to this essay called Two Separations and Two Coordinations. The first of the two separations is the separation of traditional security issues and nontraditional security issues. They are two different types of issues with distinctive characteristics. By separating them, China can benefit from flexibility and break the myth that Chinese are stiff and not willing to engage in dialogue. Traditional security issues are those involving sovereignty disputes and military confrontations that affect China’s vital national interests and security. To be more specific, it means that China cannot easily give up the nine border lines in the South China Sea, and China will not abandon sovereignty claims over its islands and their surrounding waters in the South China Sea. These are important sovereignty interests and China cannot succumb to pressure from the United States and meet unreasonable demand from relevant Southeast Asian countries, such as The Philippines. At the same time, China has to prepare for the worst: to use force to block US military power and to eliminate risk in the region. It has to develop various special military lethal weapons including aircraft carriers. In addition, China should have a positive, open, and pragmatic approach for nontraditional security issues and challenges such as resource development in the South China Sea, marine fisheries disputes, protection of international waterways and free right of passage, fights against pirates and other marine criminals, monitoring of ocean currents, and the tsunami warning systems. The Chinese nation should actively seek cooperation from countries in Southeast Asia while keeping in proper contact with major powers outside the region such as the United States to find ideas and solutions to problems. China should not use linear thinking for complex problems and take a simple friend-or-foe attitude when dealing with disputes with countries in the South China Sea. It’s an unwise idea for China to put all of its eggs in one basket and cannot let other countries have the wrong impression that China is stubbornly tough and never



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compromises. While adhering to its principles, China needs to be sincere and reasonable in dealings and exchanges with members of ASEAN and let them view China not only as a powerful country with dignity and a strong will that is ready to defend its sovereignty but also as an honest partner and a good neighbor, always willing, ready, and able to lend a helping hand. The second of the two separations is the separation of different issues in two-party and multiple-party talks. China needs to be open-minded and get rid of worries about talks in which multiple parties are involved, and must differentiate important issues in the South China Sea and handle them individually. In two-party talks, usually between China and the other country with which there are disputes over islands and waters in the South China Sea, there is not a unified model to follow as every issue involves a different country and waters with a particular history and unique demand. In some cases, two-party talks are the only way to reach an agreement. But for issues of a non-sovereignty nature, especially situations about international open waters where many parties get involved, such as the freedom of international navigation, joint use of marine resources as stipulated by the Convention of the Law of the Sea, the Strait of Malacca traffic rules and relevant safety measures, multinational joint search and rescue exercises, rules and agreements of various navies for fishery disputes, and collective actions by major forces, China should follow the rules of ASEAN dialogue and negotiations. These are the preferred methods of resolution and promote cooperation among countries. China should play the role of a kind and mild-mannered big brother. The use of multilateral mechanisms and international laws to resolve disputes between nations has become the general trend in post-Cold War international politics and diplomacy. China has little understanding and experience in this area. We should accept the concept of multilateral systems and learn how to use them and master the international rules of procedure so people will respect what we have to say regarding how to resolve regional issues. The first of the two coordinations is the coordination among different departments and different branches of the Chinese government. Through special national conferences and a coordination mechanism, China needs to coordinate work among units of the Chinese navy and air force, fishery sectors, maritime surveillance and maritime traffic enforcement units, offshore oil and gas drilling companies, diplomatic and foreign trade offices, public relations departments, and various central and local government branches so that nobody acts alone. China should note that its current coordination mechanism needs improvement and consider the need to

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establish a more powerful government branch, such as a “maritime work group” or “State Council maritime office,” led by one of its top leaders. The idea for such a branch with important decision-making power is to let everybody know that the ocean is a big part of China’s whole plan, that the maritime economy must increase its weight in China’s national economy in this new age, and that maritime security has to play a more important role in our national defense and military modernization. How to handle and resolve sovereignty disputes over its waters will have a direct impact on China’s overall strategy of establishing itself in the AsiaPacific region and leading Asia into a new era. The second of the two is the coordination among the South China Sea, the East China Sea, and the Yellow Sea. Resolution of issues in the South China Sea will provide examples of how to resolve similar issues in the East China Sea and the Yellow Sea. Coordination in the South China Sea will lead to coordination in the East China Sea and the Yellow Sea. No matter how many particular differences exist among these waters, the general method of coordination will be the same. Not only must the Chinese navy have a strategy on how to break the traditional island chain blockade in the future in the East China Sea, it must also coordinate with the Chinese army whose stated mission in the new age is peaceful development, win-win cooperation, and safeguarding the stability of the world. The Chinese navy needs to build a bigger fleet with more advanced equipment and more tonnage that can match US and Japanese navy fleets; at the same time, it should take advantage of certain strategies in the United States and Japan security alliance, such as the exploration and use of oil and gas resources in the East China Sea. Doubtless, the question is not whether or not the Chinese military will have coordination in its three seas, it is whether or not China will do it aggressively or is pushed to strike back. Coordination in the South China Sea will not only give us a picture of the future of the other seas surrounding our land but it will also reveal if China will benefit from East Asia and lead the new Asia. Simply put, China’s goal is to do its best to resolve the South China Sea sovereignty disputes peacefully and with the greatest sincerity. It aims to cooperate with other nations to develop and harvest maritime resources in the region. It will learn and will master negotiating skills involving two and multiple parties. While pushing its fishing fleet, mining transport fleet, and naval escort fleet out to the deep ocean, it will play an active role to make the South China Sea conducive to the rise of China and benefit the surrounding countries. China hopes to make it a sea of peace and a sea of



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prosperity. In doing so, it will gain experience and create conditions for the similar future of the East China Sea and the Yellow Sea. V. Protecting the Expanding Overseas Chinese Interests One of the new implications and characteristics of Chinese national security in this new reform and development period can be understood in the way expanding Chinese overseas interests are protected. China has to develop a global vision and use its military assets, diplomatic skills, business, etc., to protect Chinese citizens’ personal safety and their property rights according to the norms governing international relations. China should also provide security support in and around various international properties that are relevant to China’s interests, such as oil and gas pipelines, offshore drilling platforms, and transportation lines and routes that cargo ships, oil tankers, and passenger ships use. Preventive measures need to be taken to deter all kinds of nontraditional security threats to Chinese interests overseas. The scope of a nontraditional security threat is wider than traditional security threats and it includes more international groups. China should develop new ideas and new ways to deal with this kind of threat. There are two examples that show how nontraditional security threats are challenging. One of them is energy security. Today, the speed and scale of Chinese economic growth is the highest in the world. This large economy, feeding more than a billion people, has had an annual growth rate of about 10 percent for more than 25 years and has not shown any signs of slowing down. Based on this, Chinese energy security became a major issue that is worrisome. China has rich coal reserves, but its oil and gas reserves are relatively limited. As ordinary families buy more consumer goods, such as cars, and because the current Chinese industrial structure is not sound enough and too much energy is used, China has an increasing need for foreign oil, gas, and other energy sources. Recently, China’s oil imports have reached 55 percent of total domestic consumption and has become the biggest oil-importing country in the world. Since the late 1990s, with oil and gas at the top, energy security, energy diplomacy, and energy business have become important topics in China’s foreign relations. The big question China needs to ask now is how it can ensure that the fast-growing Chinese economy will continue to have a safe and reliable energy supply in this period of strategic opportunities.

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Frankly speaking, China’s current diplomatic skills and military power cannot help much. If Chinese companies overseas were in danger, such as its ships being hijacked, transportation lines blocked, or its offshore oil drilling platforms and pipelines attacked, the deterrent power and rescue capacity of China’s State machine is much smaller compared with some other developed countries. The second issue is the safety of China’s citizens. About thirty years ago and before China’s current reform and opening-up, the total number of Chinese people abroad was 280,000. Now the number is 70 million people a year. Considering the huge base and growth trend of the Chinese population, the number of Chinese people going abroad will increase greatly in the future. This trend explains why the media coverage of Chinese people facing danger increased dramatically. That in turn attracts the attention of our people and frequent instructions from our top leaders. Perhaps some time in the future, the majority of Chinese families will have a member or members abroad, more and more of Chinese families’ incomes will derive from activities with companies and people abroad. A large part of China’s total GDP will come from its profits abroad and international business and affairs will become one of the priorities for its leaders. So, from now on and in the foreseeable future, it is quite possible that the new requirement for the Chinese military is to provide escort in some dangerous waters to prevent pirate attacks on Chinese passenger ships, oil tankers, and the crews and passengers on board, to send navy ships to evacuate Chinese residents and students in emergencies, to give warnings to our enemies on land from our ships in international waters, take special measures to control some extremely dangerous external infectious diseases, and make preventive strikes in certain sudden international crises when Chinese citizens are in grave danger. From the national defense and national security points of view, the most important thing is that all of the above situations require China’s security interests overseas to demand that the Chinese military can go outside of normal parameters to take actions in wider spaces and on wider waters. This requires that not only the equipment and technology of the Chinese military meet the battle field demand in different countries but it also means that China has to raise the requirements for the quality of military personnel and command systems. For example, military personnel have to learn international laws and practices, languages, history, political, and economical situations of the target countries. They have to understand the implication of Chinese interests overseas. Even though these requirements do not need to be met in the near future, the Chinese military must



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see the general trend clearly. Relevant projects, education, and combat drills must be added to build China’s national defense. VI. Assuming Appropriate Responsibility for World Peace and Security If the first four missions mentioned in the above sections are for China’s own national security, then assuming responsibilities for international security and making it a mission for China will reflect China’s sense of purpose and duty as a significant international power. This mission will help to quiet the talk of a threat from China and brighten its international image. Working hard for China’s national and international security in this new period will help it to contribute more to world peace and development. It will also make the Chinese military familiar with and adaptive to all different geographical and weather conditions abroad when they perform tasks overseas to safeguard Chinese interests and sovereignty rights. Lastly, it will help the general public in China to understand and support our international security strategy and necessary military actions abroad. China’s international responsibilities include the following: (1) publishing a Defense White Paper on a regular basis, declaring to the international society the security missions and responsibilities of China, its people, its military, and the ways to fulfill them, explaining what China has done and should do for international peace; (2) educating its citizens and its military about China’s rights as a nation and obligations to the international society and possible challenges and difficulties, raising its citizens’ security awareness and sense of duty for global peace; (3) keeping regional peace and stability, encouraging dialogue among regions and sub-regions on security issues, taking steps to enhance mutual trust; establishing security procedures that benefit countries in the region; (4) mitigating the common threats from international terrorists, religion extremists, and other separatist forces in the region and globe; taking joint military actions against these crimes; (5) monitoring regional conflicts and hot spots on a global, real-time basis; paying close attention to uprisings, crises, and military conflicts in every part of the world; (6) sending peace-keeping forces and military observers to countries and regions of wars and conflicts according to the United Nations charter and the relevant Security Council resolutions; (7) providing special care and protection for the high seas, ocean floors, the Arctic, and outer space for they belong to the whole world, and their peaceful use should be monitored; (8) preventing the spread of

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weapons of mass destruction such as nuclear and biochemical supervision among countries and establishing a strict control system for relevant technologies and materials; (9) setting up registration and monitoring systems for the sales, transfer, and use of land mines and other small weaponry; preventing a bad arms race that would harm regional stability and the common interest of the globe; initiating and promoting discussions on global security issues at the General Assembly of the United Nations and its specialized agencies;1 (10) condemning and resisting hegemonies and power-politics behavior of a few countries in international security and making efforts to lead the international society into a just and fair new world order. The security responsibility a large country takes for the world may lead to conflicts with the mission and security interest of its own nation. Various tasks and use of resources earmarked for national defense will naturally lead to competition. How to resolve these issues under the principle that national interest comes first will become a frequent topic during the meetings of China’s leaders. In fulfilling its obligations to the world, China will have some inevitable conflicts with a few countries. In this period of peaceful rise, China does not want to see this happen, but it has little choice. So the Chinese must try to understand the nature of this issue, pay close attention to the changes, and handle it properly and with great care. The above-mentioned missions have their sequence, but their relevant importance can change. China has to be ready to make dynamic adjustments according to changes in situations and forces. All these missions have this in common: In realizing them, the peaceful rise of China will become a reality from a simple slogan, and China will do more good things to keep the world a safer place.

1 For such a big and independent country as China, the problem and challenge is how to differentiate various arms control actions initiated by a few western countries with their own interests in mind. For example, there is the Proliferation Security Initiative (PSI) with arms control proposal put forward by United Nations and accepted by the majority of its members (Australia, Japan, etc.), the Treaty on the Non-Proliferation of Nuclear Weapons, and the proposal on banning of bio-chemical weapons: Geneva Protocol.

CHAPTER ELEVEN

Japan’s Search for a National Identity and Its Historical Reflections Li Wei* Abstract: The Japanese government, led by the Democratic Party of Japan (DPJ), formulated its diplomatic and security strategies in 2011, which aim to obtain political and security interests and share economic dividends through creating a multilayered network with the China-US-Japan trilateral dialogue as the core mechanism. Japan’s new diplomatic and security policies are primarily affected by power relations in terms of traditional security, particularly by Washington’s Asia-Pacific strategies. The establishment of those strategies demonstrates that mainstream politicians in Japan and the majorities in DPJ have reached a consensus over those changes in Japan’s foreign policy. The key to underlying Japan’s strategies in the new era is Japan’s vision of its national development. Confined by over-scrutiny caused by Japan’s short-sightedness and misperceptions resulting from its far-sightedness in its understanding of the world, especially that of China, Japan’s new strategies may not help it fulfill its goal of having “normal statehood.” Japan’s national philosophy and American postwar policies toward East Asia have respectively served as the domestic and external factors preventing Japan from reflecting fully on its historical wrongdoings. Japan’s unfulfilled historical reflections have left uncertainty for East Asian security, thus it is difficult for East Asian nations to accept Japan’s quest for “normal statehood.” Keywords: Japan, historical reflections, national identity, diplomatic strategies, security strategies

Japan is at a critical turning point in its national development with the advent of dramatic changes in the world today. Searching for a clear national identity thus becomes an important issue it will face in the future. Japan’s self-identification is based on its perceptions of the international environment it lays in and of its own capabilities. Whether or not Japan could successfully define its national identity, however, is determined by the congruence between its diplomatic and security strategies set for this goal and the objective situation it is in. For Japan to realize its goal of being * The Chinese version of this article was first published in Guoji jingji pinglun 国际经 济评论 (International Economic Review), 4 (2012). Li Wei is Professor and Director of the Institute of Japanese Studies at the Chinese Academy of Social Sciences. Her email address is [email protected].

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identified as a “normal state,” one of the important conditions is to be commonly recognized by its neighboring countries in East Asia.1 Due to the effects of internal and external factors, Japan was unable to conduct thorough reflections on its historical wrongdoings after the end of World War II, thereby not only hindering the growth of its cognitive ability but also affecting its reconciliation with other East Asian countries, especially with China and Republic of Korea. Therefore, Japan’s inability to reflect upon its history would become an obstacle preventing it from achieving “normal statehood.” Starting from an analysis of Japan’s diplomatic and security strategies in 2011, this article seeks to uncover Japan’s objective set for groping for a national identity and investigates the obstacles blocking Japan’s pursuit of such an identity—its lack of historical reflections on its past deeds—thus demonstrating the complicated nature of the Japan issue. I. The Depth of Japanese Diplomatic and Security Strategies: The Identity of a “Normal State” The Japanese government led by the Democratic Party of Japan (DPJ) formulated its general diplomatic and security strategies in 2011. In a speech delivered to the Japan National Press Club on December 14, 2011, Foreign Minister Koichiro Gemba indicated that Japan’s diplomacy aims to maximize its national interests. According to Mr. Gemba, in order to evade risks while seizing opportunities, Japan should continue taking the JapanUS alliance as the linchpin of its diplomatic and security policies while building a framework for various bilateral, trilateral, and multilateral dialogues in the Asia-Pacific region to carry out various types of coordination and support the creation of a new international order conforming with international law. Mr. Gemba specifically emphasized that “China’s development offers opportunities;” “the creation of an open, multilayered network in the Asia-Pacific region will definitely require the full participation of China;” and “we are entering an era in which strategic dialogue and cooperation between Japan, the United States and China should be more important than ever.” That speech given by Foreign Minister Gemba on behalf of the Japanese government has elaborated on the diplomatic and security strategy of the DPJ administration. In short, the strategy aims 1 The term “normal state” is translated from Japanese “普通の国,” meaning the political and military independence of Japan. It was first proposed by Ichiro Ozawa in the early 1990s.



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to obtain political and security interests and share economic dividends through creating a multilayered network, with China-US-Japan trilateral dialogue as the core mechanism. The establishment of Japan’s diplomatic and security strategies is based on its understanding of the development of the international and regional situations, which is primarily affected by great power relations in the traditional security sense, particularly by the Asia-Pacific strategies of ­America.2 As Mr. Tsuneo Watanabe, senior fellow of the Tokyo Foundation, has stated, “The year 2011 is very important for Japan,” and “America’s return to Asia has offered Japan a good opportunity to implement its China policy.”3 America’s strategic shift eastward has enhanced Japan’s sense of presence in US strategy. In his above-mentioned speech, Foreign Minister Gemba also pointed out that “President Obama stated that Washington was going to review its diplomacy and security priorities and would place the greatest importance on the Asia-Pacific region. This new policy is very encouraging, as Japan-US cooperation in the Asia-Pacific region has been and will remain a pillar of Japan’s diplomacy.”4 In 2011, in a high-profile manner, the United States announced the eastward shift of its strategic focus, and its intention of containing China’s expansion, thus binding Japan as its principal ally in the Asia-Pacific region. Meanwhile, the United States has fortified Japan’s political identification with it through advocating “Operation Tomodachi” after the Great East Japan

2 The “Diplomatic Bluebook 2011”, published by the Japanese Ministry of Foreign Affairs on June 30, 2011, generalized the world situation as the following: “the basic structure that has underlain today’s peace and prosperity is changing”, “emerging countries . . . have achieved rapid economic growth and strengthen their influence not only in economic area but also in overall international politics, the relative influence of the developed countries has declined . . .” (Page 12). The Bluebook specifically indicated Japan’s concerns about potential threats from the Korean Peninsula and China, stating that “it became readily apparent that the security environment in East Asia was harsh”, therefore, Japan should be: (1) deepening the Japan-US alliance; (2) strengthening its self-defense forces. Japan issued its “National Defense Program Guidelines” in February 2010, in which Japan’s “reliance” on self-defense forces was changed into “stressing” on the self-defense forces, that is, the new concept of “Dynamic Defense Force” was introduced to supersede the prior “Basic Defense Force” concept; (3) creating multilayered networks; (4) advancing economic diplomacy (pp. 17–19). 3 Watanabe Tseneo, “U.S. Returning to Asia has Offered Good Opportunity to Implement its China Policy [米国のアジア回帰は日本の対中政策に好機]” Toyo Keizei [週刊東洋経済], January 14, 2012, pp. 72–73. 4 Koichiro Gemba, “Japan’s Prosperity Depends on its Ties to the Asia-Pacific [日本 の豊かさはアジア太平洋地域とともに]” (speech, the Japan National Press Club, Tokyo, December 14, 2011). The Chinese version of the speech was provided by the Japanese Embassy in China.

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Earthquake on March 11, 2011. Moreover, the “2+2” meetings between Tokyo and Washington further cemented the strategic importance of the Japan-US alliance and its role in maintaining regional security.5 Taking the opportunity created by the eastward shift of America’s strategic focus, Japan carried out new strategic actions in the Asia-Pacific region as the principal ally of the United States. The evolution of Japan’s diplomatic and security strategies recently demonstrates that mainstream politicians in Japan and the DPJ majorities have reached a consensus on this issue. Such a consensus has not only inherited the political and diplomatic guideline of the Liberal Democratic Party (LDP)—considering the Japan-US military alliance as the pillar for Japan’s security, but also displayed more flexibility compared with the LDP’s policy of “leaning to the US side.” In comparison with his predecessors Yukio Hatoyama and Naoto Kan, the incumbent Prime Minister Yoshihiko Noda gained a clearer understanding of the necessity and availability of the Japan-US alliance. Calling himself a “loach,” Noda insists that Japan should “walk on two legs,”6 meaning that Japan should maximize its diplomatic autonomy and utilize its military resources while stressing the importance of constructing Japan’s diplomatic and security strategies based on the Japan-US alliance.7 America’s worsening fiscal situation will offer Japan more responsibilities and more maneuvering space in the Japan-US alliance. Meanwhile, the functional characteristic of the JapanUS alliance as the tool for Japan to maximize its national interests will become more conspicuous. Therefore, Japan’s diplomatic and ­security 5 The Japan-US Security Consultative Committee (“2+2” meeting), participated by American Secretary of State, Secretary of Defense and Japanese Minister of Foreign Affairs and Minister of Defense, was held in Washington D. C. on June 21, 2011. One thing worthy of notice is that, (the Joint Statement of the Committee) was the first document reached by the United States and Japan under the Democratic Party on the deepening of the USJapan alliance, it was also an act “fully reaffirming the US-Japan Common Strategic Objectives” after four years (commentary made by the Nihon Keizai Shimbun on June, 23, 2011). Formed with China as the key issue, the Objectives included new contents about improving trilateral relations such as the “Japan-US-South Korea” ties, the “Japan-US-India” relations, relaxing Japan’s three Principles on Arms Export, improving US-Japan cooperation in areas of space and cyberspace security, maintaining the freedom of navigation at sea, etc. 6 Yoshihiko Noda, “My Political Philosophy [わが政治哲学],” Voice (November 2011), pp. 44–65. 7 Japanese Prime Minister Yoshihiko Noda delivered a Policy Speech to the Diet on Jan. 24, 2012. In the fourth section of the speech “Foreign and Security Policy to Open the Asia-Pacific Century,” Noda specifically mentioned Japan would make continued efforts to “play a proactive role in the creation of order and rules in the (Asia-Pacific) region.”



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strategies are rapidly shifting from the traditional way of managing Japanese strategies under the Japan-US alliance in the LDP era to the new making of the Japan-US alliance within the Japanese strategies. The essence underlying Japan’s diplomatic and security strategies outlined by the DPJ administration is Japan’s vision of its national development. In an article titled “My Political Philosophy,” Yoshihiko Noda clearly stated that the Japanese people “should fully prepare themselves to protect their own country by ourselves, and, based on that position, unswervingly adhere to the valuable Japan-US alliance.” Such a remark has not only demonstrated the political ambitions of Noda and other Japanese politicians but also reflected the fact that Japan has never given up its long-cherished hope of fulfilling normal statehood in spite of the past Lost Two Decades and the catastrophic Great East Japan Earthquake. It is notable that beneath a series of diplomatic and security actions taken by Japan, there lie its strategic objectives of expanding Japan’s strategic influences and strengthening its self-defense power. Japan’s current diplomatic and security strategies are the process experienced and means utilized to approach its ultimate goal of realizing normal statehood. Since the end of World War II, most Japanese politicians have shared the longcherished wish of pursuing the identity of a normal state, although varied strategic means have been adopted for that goal in different stages. Under Prime Minister Shigeru Yoshida, Japan concentrated on developing its economy while handing its military defense to the United States. When Japan became the world’s second largest economy, the need to fulfill its political aspirations began to surface and its quest for normal statehood shifted from a hidden hope to a public political slogan. Politicians have had disagreements on how to realize the normal statehood. For example, while Yukio Hatoyama advocated focusing on Asia and establishing a more equal relationship with the United States,8 the majorities represented by Yoshihiko Noda preferred to take advantage of the Japan-US alliance to achieve Japan’s military autonomy.

8 Chinese “Reference Materials” published on June 2, 2010 reprinted the “Full Text of Prime Minister Hatoyama’s Farewell Address” issued by the Japanese Kyodo News Agency. In his address, former Primer Minister Yukio Hatoyama claimed that “we must pursue the day when the Japanese people can create peace for themselves. I do not believe it is a good idea for Japan to depend on United States for her security.”

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Behind Japan’s strategic action, there are Japan’s views of its identity in a changing international environment, and Japan’s role it attempts to play in a shifting world order. The diplomatic and security strategies Japan forged in 2011 may not necessarily help it fulfill its quest for normal statehood. First, Japan chooses to stick to its traditional way of aligning with the most powerful nation to ensure its strategic security, as it has experienced in modern times, but such an alliance is inherently unstable since it always fluctuates with shifts in the balance of power among nations. Second, Tokyo placing the Japan-US alliance ahead of its bilateral ties with others embodies unavoidable contradiction. For example, the SinoJapanese relationship is not similar to China’s relations with the JapanUS alliance, nor could the Sino-US relationship be equalized to China’s relations with the Japan-US alliance. Moreover, Japan’s bilateral ties with other states will not function in the same way as the Japan-US alliance does. Moreover, Japan has accelerated its pace of breaking away from the binding of the Peace Constitution, although its diplomatic and security strategies based on the Japan-US alliance temporarily stopped security debates in Japan. Japan aligns with the US now in order to create conditions to separate itself from the US in the future. It remains unknown if the United States would tolerate such an action or if Japan could bring peace to Asia once it divorces itself from the Japan-US alliance. What caused Japan to make these choices? Japan’s diplomatic and security policies consist of two strategies relating to the United States and China respectively. At present, “the influences of China on Japan’s domestic and foreign affairs have been increasing in an unprecedented way, which would determine the evolution of Japan’s foreign policies to a large degree, especially its security strategies.”9 With regard to Japan’s relationship with China, it displays the dual characteristics of guarding against China on security issues while engaging China deeply in the economic sphere.10 In the security domain, Japan’s different political identifications

  9 Feng Zhaokui 冯昭奎, “Fazhan yu shijie chaoliu xiangyizhi de zhongri guanxi 发展 与世界潮流相一致的中日关系 [Developing a Sino-Japanese Relationship Conforming to the World Trend],” Japanese Studies 6 (2010), pp. 5–18. 10 See Wu Huaizhong 吴怀中, “Riben duihua anquan zhengce de lilun fenxi 日本对华 安全政策的理论分析 A Theoretical Analysis on Japan’s Security Policies towards China,” Japanese Studies 2 (2012), pp. 5–18.



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with China and the United States are the major factors affecting its strategic options. The less Japan identifies with any country psychologically, the more Japan guards against it strategically. Mutual distrust and precautions between China and Japan originate from a series of complicated reasons, including historical issues, territorial and sovereign disputes, and China’s rapid rising of power. Consequently, it is impossible for them to ease such precautions or construct strategic mutual trust in the short term. In the economic sphere, relying on China’s robust growth momentum to sustain and boost Japan’s economic vitality has become a matter of fact, on which the Japanese economic circles have reached consensus as well. Therefore, what we notice is that, faced with the dilemma of pursuing normal statehood with relatively shrunken national power, the Noda administration seeks to maximize Japan’s national interests amid China and the United States. To do this, Japan utilizes the Japan-US alliance to expand its influence in the diplomatic and security spheres on one hand while depending on China’s economic development to spur its own growth on the other. Japan’s self-identity is determined more by its perceptions of China. Whenever there is fallacy in its perceptions of China, there will be a mistake in Japan’s self-identity. Historically speaking, faced with the impetus of Western rules on the order of East Asia, modern Japan has taken China as its reference in its pursuit of a national identity all along. Japan’s self­identity forged gradually corresponding to its changing perceptions of China. On one hand, Japan viewed Asia and China as symbols of backwardness while labeling itself as representative of civilization in order to display its differences from the former. On the other hand, perceiving China and Japan as “self,” Japan was also concerned about “others” in the West.11 Responding to the “Western power spreading to the East,” Japan established a strong centralized state under the rule of the Emperor through the Toubakuundon Movement and the Meiji Restoration. Meanwhile, Japan successfully escaped from being colonized and became a member of the capitalist world by enforcing policies such as “promoting civilization and enlightenment,” “encouraging industrialization,” and “enriching the country, and strengthening the military.” Japan’s restoration led to changes in its self-identity and its attitudes toward China. From different perspectives, the thoughts of modern Japanese thinkers Yukichi Fukuzawa and Kakuzo

11 Sun Ge 孙歌, Zhuti misan de kongjian 主体弥散的空间 [The Spreading Space for Objects] (Nanchang: Jiangxi Education Publishing House, 2002), p. 104.

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Okakura demonstrated Japan’s dual identities when confronting China.12 One identity was a Japan leaving Asia; the other was a Japan representing Asia, both of which transferred icons of civilization from Europe or China to itself. In other words, no matter whether it differentiated itself from Asia and China, stereotyped as being backward, or compared itself with Asia or China as a symbol of civilization,13 Japan’s dual identities ultimately reflected its nature of being an imperial national state. One thing worthy of notice is that Japan’s self-identification was restricted by over scrutiny caused by short-sightedness and misperceptions resulting from far-sightedness in its perceptions of the world, especially that of China. In order to understand China, the Japanese society and government had made great investments. Besides in mainland China, Japanese media correspondents and businessmen, Japanese military intelligence units, the Nisshin Trade Institute,14 Toa Dobunshoin,15 and the research department of the South Manchuria Railways Company16 also conducted systematic and organized research on China. These investigations were comprehensive and lasted for an extended period of time. They resulted in analyses so profound and pertinent that they were the major reasons why Japan could repeatedly succeed in encroaching upon China’s interests. However, Japan’s short-sighted scrutiny of China at the micro-level did not necessarily mean that it had a precise understanding of China at the macro-level. Japan underestimated China’s cohesion and

12 Qian Wanyue 钱婉约, Cong hanxue dao zhongguoxue 从汉学到中国学 [From Chinese Studies to Studies of China] (Beijing: Zhonghua Book Company, 2007), pp. 213–216, pp. 228–235. 13 QianWanyue argued that in his “Datsu-A Ron,” Yukichi Fukuzawa firstly conveyed Japan’s feelings of national crisis, then its disappointment with China. The concept of Asia which Japan chose to “leave” was not a gerographical one, but was a symbol of backward civilizations. 14 Founded by Japan in Hankou, China, in 1890. Except for training experts to engage in business and trade with China, it also conducted research on China while editing and publishing books and documents like “An Overview of Qing’s Trade.” 15 A Japanese school established by Japan in Shanghai from 1901 to 1945, later became the Aichi University. Funded by Japan’s Ministry of Foreign Affairs, several thousands of its graduates participated in investigations of China and Southeast Asia. It had publications like “China’s Government” (18 Volumes), etc. 16 After the Russia-Japanese war (1904–1905), Japan took control of the southernmost section of the China Far East Railway. Later Japan founded the “National Policy Agency,” “the South Manchuria Railway Company” in 1906, which were normally known as “Mantetsu.” The “Research Department” of Mantetsu employed over 2,000 people at its peak time who explored China’s politics, military, economy, culture, its natural resources as well as geographical environment, etc. Enormous research documents were produced by Mantetsu, only in China, there are over 300,000 different kinds of Mantetsu documents left.



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resistance as well as its potential. Japan’s traditional scrupulousness in probing China and its strategic misperception of China remain unchanged even today. III. Inherent Defects in Japan’s Pursuit of a National Identity: Reflections on Its Historical Wrongdoings Japan embarked on the road of military aggression after debating its national identity, which was also a cognitive process in which Japan sought to understand China, East Asia, and the world. It was also a process of Japan weighing and ultimately selecting the option of participating in the capitalist expansion led by the West and endorsing the capitalist international order. Based on its perceptions of Asia and China, Japan forged its fundamental ideological framework to direct and legitimize all its military aggression, that is, facing colonization by European Caucasians, only Japan, which had “left Asia and joined Europe,” possessed the capability and the responsibility to save the yellow race. Guided by that logic, Japan’s decisions, no matter whether it adopted the coordination policy based on the Japan-UK alliance or enforced the “Asian Monroeism,” only varied in their way of dealing with European countries and the United States. In modern times, however, Japan appeared to be particularly brutal when invading and plundering Asian states, especially when encroaching upon China’s land and resources. In the name of promoting civilization, Japan legitimized its dominance of the “East Asia new order,” and its blueprint of the “Greater East Asia Co-Prosperity Sphere.” Such a self-identity of Japan resulted in severe casualties and property losses in China and other Asian countries. The postwar Tokyo trials indicated that both Europe and Asia denied Japan’s membership as a country, meaning Japan was unable to join Europe even if it had escaped from Asia. However, Japan’s activities under the dual guidance of leaving Asia and revitalizing Asia in modern times were not efficiently tackled17 with its honoring of the Yasukuni Shrine as a typical example. Since the then Prime Minister Yasuhiro Nakasone visited the Yasukuni Shrine in 1984, an act protested against by the Chinese government, Japan and China have reached a certain political compromise; primary ­members 17 Li Wei 李薇, “Chongsheng wenti de fuza yinsu jiqi shizhi 冲绳问题的复杂因素及 其实质 [The Complicated Factors and Nature of the Okinawa Issue],” Japanese Studies 5 (2010), pp. 25–34.

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of the Japanese Cabinet would no longer visit the Shrine where Class-A war criminals from World War II are honored. However, from 2001 to 2006, during the five-and-a-half years of his term as the Japanese Prime Minister, Junichiro Koizumi paid five consecutive visits to the Yasukuni Shrine, forcing Sino-Japanese relations to deteriorate to their worst level. The Yasukuni Shrine became a controversy between the two countries because the people it enshrines and its rituals have been endowed with the political implication of endorsing Japan’s military aggression against other states. Those spirits, or kami, enshrined there consist of around 2,500,000 war dead since the Meiji time, whose enshrinement has been determined by the Japanese government. Except for 14,722 people, most of those enshrined are people who fought and died in Japan’s overseas wars, especially in its invasion of China and the Pacific war, including some Class-A war criminals who were sentenced to death for committing “crimes against peace.”18 In essence, the Yasukuni Shrine is a place for state-directed kami enshrinement and worship, although on the surface it is viewed as a religious institution. There was a separation of state and church in postwar Japan. Although Japan has become a democratic state, the Yasukuni Shrine and other memorials commemorating the war dead soldiers, namely “Loyal Soul Monuments” (Chukonhi) or “Spirits Worshiping Monuments” (Iriniihi) scattered all over the country, demonstrate that Japan never severed its ties with the past. Instead, these places continue to serve as the embodiment of Japan’s nationalism.19 As a place to worship the war dead, the Yasukuni Shrine played the role of symbolizing and highlighting Japanese national values. It continues to recall and recreate memories of the war dead, reflecting Japan’s historical view of glorifying military aggression as war for self-defense. All previous acts of aggression Japan launched in modern times have been condemned by the international community and tried by the international tribunal. However, the logic of co-enshrinement as well as its inherited rites in the Yasukuni Shrine remain unchanged. Consequently, “so long as the memories of suffering cherished by individual and group victims in the neighboring states 18 During the Tokyo Trials, 28 were charged as “Class-A war criminals”. The results of these trials were: 25 were convicted, among them 7 were sentenced to death, 16 were sentenced to life imprisonment, 1 was sentenced to 20 years imprisonment and 1 was sentenced to 7 years imprisonment. Among these 28 Class-A war criminals, 14 were co-enshrined at the Yasukuni Shrine on Oct. 17, 1978, including 7 persons who were hanged after the Tokyo Trials and another 7 who died from illness during and after the Trials. 19 Names of these 14 people were provided by the Japanese Ministry of Health, Labor and Welfare to the Yasukuni Shrine on Oct. 17, 1978.



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do not disappear, frustration over and denouncement of Japan incited by its official visits (to the shrine) will never stop.”20 According to Clause 3, Article 20 of the Japanese Constitution, the State and its organs shall refrain from involving in or supporting any religious activities, meaning that the principle of “separation of state and church” shall be upheld. Since the Japanese Prime Minister and other governmental personnel bear official titles, their visits to the Yasukuni Shrine apparently constitute an infringement of the Peace Constitution. The Japanese people have been divided on this issue, since most intellectuals oppose official visits to the Shrine, although some officials and politicians insist on doing so.21 In its verdict made in 1991, the Sendai High Court judged that the prime minister’s visit to the Yasukuni Shrine was “inappropriate.”22 Six Japanese district courts even handled 10 cases filed against Prime Minister Koizumi’s visits to the Shrine, among which both the Fukuoka District Court and the Osaka High Court ruled his action to be ­unconstitutional.23 However, the Supreme Court of Japan, trying to evade judging whether the prime minister’s behavior was unconstitutional, has never heard ­similar cases. Merely issuing the Imperial Rescript on the Termination of the War would not wipe out all those spiritual sentiments accumulated in Japan for almost a century. Just because of its lack of reflections on itself, on its East Asian victims, and on its choice of road for national development, Japan’s apologies as a formality have looked insincere and unconvincing while its self-loaded historical burden has become much heavier and more complicated. One thing worthy of note is that, officials’ visits to the Yasukuni Shrine did not arouse public debates over its unconstitutionality in Japan, nor did they contribute to any crisis of confidence in the government. Many Japanese people did not attach too much importance to such issues as retaining or visiting the Yasukuni Shrine, even to the prime ministers’ visits. In the views of other Asian countries, however, Japan’s inattention to such a controversy was already inconceivable and affects their acceptance of Japan as a normal state. 20 Sun Jiang 孙江, “Jiegou jinguo shenshe de zhengzhi huayu 解构靖国神社的政治 话语 [Deconstructing the Political Discourse of the Yasukuni Shrine],” Dushu 3 (2006), pp. 5–15. 21  See Section 27 of the Chinese “Southern Weekend” published on September 21, 2006: a special interview with Professor Yōichi Komori from the Tokyo University. 22 Judgment made by the Sendai High Court in Japan on January 10, 1991. 23 Decision made by the Fukuoka District Court on April 7, 2004; and decision made by the Osaka High Court on September 30, 2005.

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IV. Internal Factors Inhibiting Japan’s Historical Reflections It is not easy for any nation to face its historical wrongdoings in a proper way. A country’s self-reflection needs courage and genuine repentance to achieve the sublimation of human conscience and the revival of moral responsibility. In a gesture deeply moving the whole world, German Chancellor Willy Brandt knelt down at the monument to Jewish victims of the Warsaw Ghetto Uprising, which not only demonstrated Germany’s sincerity and determination in conducting deep penance for its past wrongdoings and bearing its due responsibilities but also won trust and forgiveness from the whole world for West Germany, especially from European countries. Taking the European reconciliation as a reference point, Asian citizens in Japan’s victim states tend to compare the repentant West Germany, “which arose the moment when Chancellor Brandt knelt down,” with the unrepentant Japan, which exempted the Emperor’s responsibility in launching World War II. They find it difficult to understand why it was so hard for Japan to apologize. Or, it may be acknowledged that Japan will never make any sincere repentance at all. Chinese scholars have been diligently searching for the sources of Japan’s abnormality. They have first analyzed the Japanese concept of Shinto, its imperial historical perspectives, its system of emperor absolutism as well as the inherent reasons that contribute to fascism. Some researchers point out that Japan’s national mythology has been the dominant idea unifying its natural and cultural mythologies. Ancient woks such as the Kojiki and the Nihon Shoki have respectively recorded Japan’s history from the Age of the Gods to the Human Age, from the Izanagi-Izanami24 to the Amaterasu-Omikami,25 and then to subsequent emperors, who have jointly “reigned since time immemorial.” According to Japanese mythology, not only were the Japanese lands created and managed by the Gods, but the Japanese state was created by them. These myths “are rarely seen in other nations and display the unique features of Japanese mythology.” The Yamato-Damashii, or the Japanese Spirit, featured by the unity of the emperor with the state has been the philosophical root and essence of Japanese nationalism.26 Other scholars also indicate that two laws in modern Japan forged its mainstream ideological beliefs: The first is the 24 Izanagi-Izanami, the heavenly gods who created gods. 25 Amaterasu-Omikami: the Sun Goddess. 26 Li Dongjun 李冬君, “Zhouxiang xinyang de guoija zhuyi 走向信仰的国家主义 [Nationalism Heading to Beliefs],” Chinese Book Review Monthly 12 (2007), pp. 82–85.



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“Constitution of the Empire of Japan” promulgated by the Privy Council of Japan in 1889, which “confirmed national legends founded on myths as the official history of Japan in the form of modern national supreme laws.” The other was the “Imperial Rescript on Education” signed by Emperor Meiji in 1890, which made it the highest moral value for Japanese people to respect and guard the Imperial Throne. In addition, the gods-worshipping concept featuring the unity of church and state was recognized as law. Therefore “national Shinto” was extended from the “Shinto nation,” in which the emperor, as the highest priest, was at the summit of the Shinto worshipping system. “Such blasphemies against civilization and science as well as its fooling of the people in ideological beliefs are rarely seen in the modern history of the world.”27 Although the emperor of Japan descended from the divine altar after the end of World War II, he is still not a member of the “citizens” as a once “living god.” Since the emperor was exempted from his war responsibilities, the emperor system has been retained while the deity and moral image of the Imperial House remain intact. Meanwhile, the Ise Grand Shrine remains grand and mysterious as the symbol of the emperor mythology and the rhetoric of “Japan as a divine state” has never been abandoned. After the end of World War II, East Germany and West Germany abolished the national anthem and national flag of Nazi Germany. In contrast, the Hinomaru, the national flag of Japan, and the Kimigayo, national anthem of Japan, were never disposed of, thus enabling the cultural symbols of Japanese nationalism to persist until today. In 2006, the then Japanese Prime Minister Shinzo Abe urged the Japanese Diet to revise the “Fundamental Law of Education,” which reaffirmed with national authority the status of the Hinomaru and the Kimigayo as the pioneers for nationalistic education, thus inheriting and deepening Japan’s moral traditions held for generations. What was left for the Japanese people today, however, were ambiguous moral standards and historical memories. In that case, it may be easier to understand why, when Asian countries were denouncing Japanese politicians’ visits to the Yasukuni Shrine and calling for Japan to repent for its past wrongdoings, the Japanese ­political opinion legitimizing its “nationalistic feelings” and “survivors’ feelings” could be propagated so extensively in the open. It might also be easier to 27 Yan Shaodang 严绍璗, “Riben dangdai guojiazhuyi de sixiang jichu 日本当代‘国家 主义’的思想基础 [The Ideological Foundations of Contemporary Japanese ‘Nationalism’],” Collected Writings of Asia-Pacific Studies, Volume 1, (Beijing: Peking University Press, 2004), pp. 47–70.

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understand why the Japanese public could calmly embrace those religious emotions deprived of morality and rationality without pursuing the “legitimacy of such emotions.” By reframing “wars” as “incidents,” “invaded” as “advanced into” and “unconditional surrender” and “defeat” as “the end of war” in the discourse of history textbooks, as well as enshrining ClassA war criminals as “loyal souls” and “heroes” at Yasukuni Shrine, Japan has been trying zealously to justify and whitewash the war atrocities it committed in terms of details and numbers, regardless of the possibility of inflicting more pain on its victims. On the issue of reflecting on its past wrongdoings, the strength of ethics seems to be extremely weak in Japan. In exploring Japanese psychological activities, some Chinese researchers also argue that both the “Kejime (bearing the blame oneself) mentality,” which suggests “retreating for the sake of advancing” and the “self-­purification mentality,” which implies “letting bygones be bygones,” are the psychological roots of why the Japanese have been reluctant to repent for their crimes.28 In essence, no matter how hard Japan has tried to catch up with the advancing of world civilizations, its responses to the world are mainly founded on its own unchanged spiritual ideology. V. External Factors Prohibiting Japan’s Historical Reflections US postwar policies toward East Asia have been the major external factor preventing Japan from engaging in proper historical reflections. As is known to all, the demolition and reconstruction of the Japanese political system were completed hastily right after the end of World War II. Japan had to give up war and the Meiji Constitution after being forced to accept the “Potsdam Declaration.” When most of the Japanese people were still immersed in the feeling of defeat and on the verge of mental collapse, and when hunger and poverty were rampant in Japanese society, the US occupation rapidly enforced on Japan catered to the Japanese people’s material and spiritual needs for undergoing a smooth social transition. However, due to the lack of remorse for its war crimes among the whole Japanese population, the retaining of the emperor system and the revival of its prior bureaucratic systems, Japan lost the chance to conduct thorough ideological reforms. All changes that happened in Japan shortly after 28 Zhang Jianli 张建立, “Shixi ribenren de lishi renshi wenti xingcheng yuanyin 试析 日本人的历史认识问题形成原因 [A Preliminary Analysis on the Causes of the Issue of Japanese Historical Reflections],” Japanese Studies 2 (2012), pp. 147–159.



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the war were pushed from outside. Therefore, there was a lack of internal reflections relating to the war in the postwar development of Japan’s civil society. For any nation to reflect upon war crimes it committed, a country requires an extensive period for self-reflection. Only through engaging in rational self-inquiry, could anyone really sever ties with the past while heading toward a bright and new future. Unfortunately, the United States did not offer Japan either the opportunity or the time to implement spiritual trials of itself.29 As an important external actor for Japan and leader of the two conflicting blocs in the Cold War, the United States, when promoting European rapprochement, obstructed the process of reconciliation in Asia instead. Compared with its extremely steadfast attitude toward the settlement of the Nazi forces in German, Washington took an ambiguous stance and acted too hastily when addressing the issues relating to Japanese war criminals, fully demonstrating its pragmatism in conducting international affairs. In the Tokyo War Crimes Tribunal, 28 persons were indicted as Class-A war criminals. Except for three who died of illness, 25 military officers and politicians were either sentenced to death or imprisoned. Although Japan’s invasion of China since the Mukden Incident had been indicted as war crimes in the Tokyo Trials, the Allied Forces still tended to categorize Class-A war criminals as “politicians or military leaders who insisted on launching war against America.” Consequentially, Kanji Ishiwara, who was primarily responsible for initiating the Mukden Incident, was not charged with Class-A crimes. In addition, Nobusuke Kishi, who was a top official in Manchukuo (满洲国) when Japan occupied China’s northeast and later a member of the Hideki Tōjō cabinet, was not indicted and was released later. It is well known that Unit 731 of the Japanese Army conducted lethal human experimentation continuously in Northeastern China while researching and developing biological weapons prohibited by international law. However, “those in Unit 731 who committed such crimes were exonerated since they agreed to provide experimental data to the United States.”30 The US government made such decisions “because it believed that the reconstruction of postwar Japan had to rely upon

29 Li Wei 李薇, “Chenggong yu yihan—riben zhanhouxianfa de zhiding 成功与遗 憾——日本战后宪法的制定 [Successes and Regrets—forming of the Japanese Constitution in the Postwar Era],” Dushu 4 (2009), pp. 74–79. 30 Wakamiya Yoshibumi 若宫启文, Hejie yu minzhu zhuyi 和解与民族主义 [Reconciliation and Nationalism], Trans. Wu Jinan 吴寄南 (Shanghai: Shanghai Translation Publishing House, 2008), pp. 117–118.

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those pro-US and pro-UK forces. In addition, the United States had its political calculations by exonerating Emperor Hirihito for involvement in the war.”31 The historic significance of the Tokyo Trials was indisputable since it upheld justice while bringing world peace back on track. However, its major defect was its lack of Asian representatives in the trials.32 As John W. Dower has indicated, in the panel of 11 judges, only three were from Asian countries, among them the Philippine and Indian judges were chosen mainly because their home countries were once colonies of the United Sstates and the United Kingdom. In Dower’s view, these Asian judges were merely “figurehead representatives” of Asia. Meanwhile, it seemed that the anti-Japanese war was not fought in Asia’s sovereign states, and the Tokyo Trials were conducted irrespective of the contradiction between the colonial and imperial world dominating the trials and the lofty ideal of indicting crimes against peace and humanity via the trials.33 Therefore, the Tokyo Trials did not eradicate but concealed Japan’s colonizing history and its ideologies, in stark contrast with the settlement of the Nazi forces in Europe. Such a result would naturally lead to the unresolved issue of Japan having no efficient reflections on its past wrongdoings. It should be noted that Japan in the postwar era has been vacillating between reaching reconciliation with other East Asian states and upholding Japanese nationalism. “Making historical issues contemporized” and “turning contemporary issues into historical ones” have formed a vicious circle in Japanese politics. VI. Conclusion Japan’s unfulfilled historical reflections have left uncertainties in the maintenance of peace in East Asia. Japan’s East Asian neighbors have not acknowledged Japan’s pursuit of “normal statehood,” nor will it reassure its ally—the United States—let alone achieve its goal of becoming the leader in Asia as a political power. “Japan has tried all along to 31  Ibid., 117. 32 See in Onuma Yasuaki, From Tokyo War Crime Trial to Thought of War Responsibity [東京裁判から戦後責任の思想へ], (Yoshindoukoubum Press [日本有信堂高文社], 1997). 33 John W. Dower 约翰·道尔, Yongbao zhanzheng 拥抱战败 [Embracing Defeat: Japan in the Wake of World War II], Tran. Hu Bo 胡博 (Beijing: Beijing Sanlian Bookstore, 2008), p. 448.



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d­ ominate East Asia since the collapse of the Tribute system, however, it has never become the heart of the order in East Asia anytime in history,”34 which is inseparable from its misperceptions of its identity. Japan still needs to attach great importance to reflecting properly on its past wrongdoings in order to achieve normal statehood. In the process of realizing self-identification, Japan could embark on the way of peaceful development. It is the author’s wish that Japan could develop into the “Switzerland in Asia,” which is delicate, beautiful and quiet. Going this way will better help Japan to make full use of its technological and environmental advantages and to build a better image in Asia to accomplish reconciliation with others. However, Japan will not be willing to do so, since Switzerland is too small in size. After all, Japan has been used to calling itself the “great Japan.” In short, Japan will face more challenges in its quest for a national identity.

34 Zhang Jianli 张建立, “Shixi ribenren de lishi renshi wenti xingcheng yuanying 试析 日本人的历史认识问题形成原因 [A Preliminary Analysis on the Causes of the Issue of Japanese Historical Reflections],” Japanese Studies 2 (2012), pp. 147–159.

Part four

RMB as an international currency

CHAPTER TWELVE

Overcome the Fear of RMB Appreciation Yu Yongding* Abstract: Different views on the RMB exchange rate among Chinese economists reflect different views among them on more fundamental issues such as China’s future development strategy. The paper is aimed at refuting the currently prevalent arguments opposing RMB appreciation. The paper also comments on various proposals on the reduction of RMB appreciation pressure and the postponement of the adjustment of the RMB exchange rate. The paper argues that, despite the success of China’s development strategy characterized by foreign direct investment attraction and export promotion over more than the past two decades, the growth pattern is imbalanced and hence unsustainable. China needs to achieve a paradigm shift from the imbalanced growth to a balanced one as soon as ­possible. Keywords: Fear of RMB appreciation, exchange rate stability, balanced ­development

I. Introduction Recently, the RMB exchange rate became a focal point of public debate. In fact, under the current macroeconomic situation, the exchange rate issue is far from as vital and urgent as it was during the Asian financial crisis in 1997–98. Unless the appreciation of the RMB exchange rate is large, some appreciation should not seriously impact the economy. However, the overwhelming consensus and the high pitch against RMB appreciation among Chinese economists as well as mass media are worrisome, let alone the fact that many rationales put forward against RMB appreciation are dubious, to say the least. Recently, Premier Wen Jiabao pointed out: “To keep the RMB exchange rate basically stable is not only conducive to China’s stable economic and financial development, but also conducive to the stable economic and * The original Chinese version of this article was first published in Guoji jingji pinglun 国际经济评 [International Economic Review] 4 (2003). Yu Yongding is the first academician of the Chinese Academy of Social Sciences (International Studies). His email address is [email protected].

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financial development of China’s neighboring countries”1 . . . China has adopted a unified, managed and market-based floating exchange rate system, which suits China’s reality.”2 Certainly, the premier’s view cannot be more correct. His main message is that despite numerous pressures, the RMB exchange rate will be kept basically stable. But he also left some room for China to adjust its exchange rate policy in the future. To keep the RMB exchange rate basically stable does not mean that there cannot be change in the RMB exchange rate. If the RMB exchange rate has appreciated by 1 percent, 2 percent, or 3 percent vis-à-vis the US dollar, does it mean that the RMB exchange rate is no longer basically stable? The answer is no. Even under the strict fixed exchange rates of the ­Bretton Wood System, member countries’ exchange rates were allowed to move within a ±1 percent band around the central parity against the US dollar. Under a managed floating system, not only can the exchange rate move up and down around the central rate, but the central rate can also be adjusted in line with certain rules. For a long time until now, mass media within and outside China mistake China’s exchange rate regime as pegged to the US dollar with a fixed par rate of 1 US dollar for 8.27 yuan. In fact, since 1994 China has adopted a managed floating system. To fend off speculative attacks during the Asian financial crisis, the Chinese government was forced to abandon managed floating and shifted to the dollar peg temporarily. The dollar peg was just an expedient. The Chinese government never claimed that its exchange rate regime is the dollar peg. The fixed exchange rate system has two main merits. First, it is conducive to control over inflation. According to the theory of nominal anchor, when a country suffers an international balance of payments deficit, there are two options for the monetary authority: to lower the inflation rate or allow the nominal exchange rate to depreciate. The fall in inflation will lead to the depreciation of the real exchange rate. As a result, the international balance of payments will return to equilibrium. A depreciation of the nominal exchange rate can achieve the same result, but it will lead to worse inflation. The temptation for monetary authorities to use the latter policy is great because it is an easier way to achieve short-term results.

1  Wen Jiabao 温家宝 (2013), The Stability of RMB is Conducive for the Stability of World Economy and Finance 人民币汇率稳定有利于世界经济金融稳定, http://news .­xinhuanet.com/newscenter/2003-08/05/content_1011625.htm. 2 “Wen Jiabao Met with Snow: the Two Sides Changed Views on the RMB Exchange Rate,” 温家宝会见斯诺 双方就人民币汇率等问题交换意见 http://news.xinhuanet. com/world/2003-09/03/content_1061419.htm.



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In contrast, the fixed exchange rate has many other merits. First, with a fixed exchange rate, the monetary authorities have no other options but to work very hard to lower inflation. Hence, a fixed exchange rate regime will increase the credibility of monetary authorities’ anti-inflation policy. Second, the stability of the exchange rate will increase certainty in the economy and as a result is conducive to economic growth. For example, a sudden appreciation of local currency will wipe out enterprises’ gains after cutting costs and the enterprises will lose incentives for making such efforts. Third, the change in the exchange rate will lead to a change in the price structure of the economy, which in turn may cause some price distortions at least temporarily. Hence, the fixed exchange rate may reduce the chance for such distortion. However, the fixed exchange rate also has serious defects. A country’s comparative advantage will change following the alteration in the relative prices among trading nations. The government can keep the nominal exchange rate unchanged by intervention in the foreign exchange market, but it cannot keep the real exchange rate unchanged. The changes in the real exchange rate may lead to “misalignment of exchange rates,” which, in turn, if the nominal exchange rate has become overvalued, will lead to balance of payments deficit and hence a currency crisis or serious misallocation of resources even without a crisis. A flexible exchange rate will be able to alleviate such problems, especially since the flexible exchange rate is very resilient in the face of attacks by international speculative capital. In the 1990s, all the countries that were hit by currency crises were countries with fixed exchange rates. In contrast, none of the countries that adopted flexible exchange rates suffered currency crises. According to the well-established theory of impossible trinity, it is only possible to have two of the following three things: a fixed exchange rate, free flow of capital, and independence of monetary policy. As a large economy, there is no doubt that China has to maintain the independence of monetary policy. At the same time, China decided to push a gradual liberalization of its capital account. As a result, China has to discontinue the dollar peg and allow the RMB to float. However, due to the fragility of its financial system and other structural and institutional constraints, the Chinese economy is not resilient enough to endure the effects of large fluctuations of the exchange rate. In other words, currently and in the foreseeable future, China cannot adopt a free-floating exchange rate, and it has to wait until its economy meets the necessary conditions. Hence, a managed floating is the best option that China can have at the moment.

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Certainly, managed floating is also flawed with problems. For example, when there is strong appreciation pressure, the exchange rate may hit the ceiling of the pre-set exchange rate band immediately without eliminating the appreciation pressure entirely. When the central rate of the exchange rate band is adjusted upward, the exchange rate may immediately hit the new ceiling again. When there is depreciation pressure, a similar adjustment process in the exchange rate will happen, but in the opposite direction. Because of the difficulties in the management of exchange rate expectations under the managed floating system, some economists argue for the two-corner solution: either adopting a currency board system as in Hong Kong and Argentina or complete free-floating. For them, any halfway exchange rate arrangements will not work. However, experience shows that the idea of the two-corner solution is wrong; despite all the defects, the managed floating system allows either appreciation pressure or depreciation pressure to be released gradually so that the effects of exchange rate fluctuations on the economy can be reduced. At the same time, financial and nonfinancial corporations gain some breathing time to adapt to the changed circumstances rendered by changes in the exchange rate. While China should maintain the exchange rate system of managed floating and let it work as such at the moment, in responding to global and regional economic development China can consider adopting other exchange rate regimes such as pegging to a basket of currencies in the future. During the Asian financial crisis, East Asian countries, except for China, sharply devalued their currency. However, as pointed out, by Prof. R. I. McKinnon, “After the crisis, the East Asian dollar standard resurrected.”3 He used this fact as a rationale to dismiss the free floating or the managed floating strategies as unfeasible in East Asia. Indeed, countries in the region have the preference to peg their currencies to the US dollar. This preference is attributable to facts such as the region’s reliance on US markets, the US dollar’s dominant role in trade settlement, the East Asian region’s financial fragility, and the trend of the US dollar devaluing against the Japanese yen. China also faces these situations. However, China’s economic reality is very different from other economies in the region, let alone the fact that those East Asian economies have not shown intentions to reinstate the dollar peg, although they tried to stabilize the 3 R. I. McKinnon, “After the Crisis, the East Asian Dollar Standard Resurrected: An Interpretation of High-Frequency Exchange Rate Pegging,” American Economic Review 53 (2000): 717–25.



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exchange rates of their currencies against the US dollar. It is also worth noting that unlike China, other East Asian economies, except for Malaysia, do not have one important policy instrument that China possesses— capital control. Hence, the practice of the rest of East Asia cannot serve as guidance for China’s exchange rate policy. II. Why Prevalent Rationales against RMB Appreciation Are Wrong During the 1997 Asian financial crisis when the temporary policy of pegging the RMB to the US dollar was introduced, the consensus among Chinese economists was that as soon as the large depreciation pressure on the RMB disappeared the RMB should de-peg from the US dollar and return to the managed floating system. Although four years have passed since the RMB depreciation pressure dissipated, why won’t China de-peg from the US dollar? The reason is simply that in recent years the US dollar has been falling against other major currencies. By riding the dollar down, the RMB has been falling against other major currencies and a competitive RMB is conducive to China’s exports and hence its growth. It is worth noting that the RMB is somewhat undervalued against the US dollar. As a result, de-pegging will immediately lead to a rise in the RMB exchange rate against the dollar. But why should China fear RMB appreciation? There are three rationales. First, appreciation will lead to a reduction in the trade surplus and even create a trade deficit, which in turn will lead to a slowdown of the economy and rise in unemployment. Second, the de-pegging and the resulting appreciation will create appreciation expectations. These expectations will lead to speculative capital inflows and the creation of asset bubbles that will impair China’s financial stability. Third, the RMB appreciation may cause deflation. Undoubtedly, there are truths in all three arguments, but they do not constitute sufficient reasons to not allow the RMB to appreciate. There are four comments on the first rationale. First, the processing trade dominates China’s trade. The key feature of the processing trade is its high import contents. Appreciation will lower the costs of imported materials, parts, and components in terms of the RMB, which to a significant extent will offset the effects of lower export prices on enterprises’ profitability. Hence, the negative effects of an appreciation of the RMB on China’s trade balance will be less than most people fear. Second, generally speaking, the elasticity of most of China’s exports with respect to price changes is low because of the specific nature of

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­China’s exports that consist of mainly staple goods. Limited price changes in China’s exports will not greatly affect foreign consumers’ demands for Chinese exports. At the same time, non-price factors heavily influence China’s imports. In fact, the changes in the volume of China’s imports often contradict price signals. For example, in recent years China bought larger quantities of oil than usual when the oil price was highest. Both experience in the Asian financial crisis and empirical studies by various research institutes show that when the magnitude of RMB appreciation is not very large, China’s trade will not be influenced significantly. In fact, during the Asian Financial Crisis, despite the devaluation of all major Asian currencies against the RMB, China’s market shares of exports in destination countries didn’t change very much. Third, economists who are against RMB appreciation frequently use the argument that the trade surplus is a result of the saving gap instead of the price competitiveness of export products to oppose RMB appreciation. If it is true, a logical conclusion must be that the appreciation of the RMB alone will not lead to significant changes in China’s trade balance. Then why worry about RMB appreciation? Fourth, running a trade deficit is not necessarily bad for economic growth. The key is if its impact on the economy as a whole is beneficial. If the deficit were a result of an increase in investment, the positive impact of increasing investments would offset the negative impact of the trade deficit on growth. Furthermore, for given investment efficiency, the increase in the investment rate enabled by the trade deficit will lead to an increase in growth potential and more job creation in the future. The prosperity of the US economy in the late part of 1990s is a relevant example. The second rationale against RMB de-pegging is also not convincing. Most foreign investors hold that the RMB exchange rate is underestimated by 20 to 30 percent. Unless there is a fundamental change in China’s international balance of payments, no matter how emphatically the Chinese government announces its no appreciation policy, investors will not regard the announcement as credible and investors will not change their expectations of RMB appreciation. But if there is a small appreciation in the RMB exchange rate, the RMB appreciation expectations will not be strengthened too greatly because the appreciation expectations have already accounted for this possibility. Even if appreciation expectations are stronger, the Chinese monetary authorities still has options available to curtail the inflows of speculative capital. The authorities can consider imposing a Tobin tax on cross-border capital movements to raise the transaction costs of short-term speculative capital movements. The



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g­ overnment also can reduce the interest rate so as to reduce the attractions of RMB assets. Another option is to let the RMB have a one-off appreciation. By doing so, RMB appreciation expectations will be eliminated entirely. Despite many difficulties, strengthening capital controls is feasible. Capital control is the last defense for China’s financial stability. Before the final completion of its property rights-centered ownership reform, China should not give up capital control. Generally speaking, one of the important purposes of implementing capital controls is the maintenance of the stability of the exchange rate. Why should China shy away from using capital controls to curb the movements of speculative capital? Currently, one guiding thought of the government is the strict control over inflows and lenient control over outflows. Indeed, some countries, such as Malaysia, implemented this type of policy. However, this guiding principle is debatable. First, to impose strict control over capital inflows is undoubtedly correct. Lenient control over outflows certainly can help reduce RMB appreciation pressure. However, it will open the floodgates for the flight of capital that corrupt officials embezzle. Second, if speculative capital can withdraw from China easily, speculators will have more incentive to get in and then leave after they have gobbled up speculative profits. Third, China’s foreign exchange administration should have a package of measures to increase the risks and transaction costs for speculators, which should serve China better in deterring speculators from trying their luck in China. It seems that there are not any insurmountable technical obstacles for China’s monetary authority to implement effective capital controls. Lowering the interest rate is an option. But the interest rate is mainly a macroeconomic policy instrument. The macroeconomic situation instead of the need to curb short-term capital inflows should decide its use. At this moment, because the economy showed signs of overheating, cutting the interest rate is not appropriate. However, letting the RMB have a large one-off appreciation is not feasible either, because its effect on the economy can be too big large to tolerate. In short, the arguments against RMB appreciation that are based on the fear of appreciation expectations are not sound theoretically as well as factually. In contrast, it is worth experimenting with the option to allow the RMB to appreciate gradually to release appreciation pressures. The third rationale against RMB appreciation is also debatable. Indeed, RMB appreciation will reduce the trade surplus or the growth rate of the trade surplus and hence reduce aggregate demand, other things being

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equal, or the growth rate of aggregate demand. As a result, downward pressure on the price level or the inflation rate will appear. However, there is not any empirical evidence that can demonstrate that under China’s current circumstances RMB appreciation will create deflation. When arguing that Japan’s deflation was a result of the appreciation of the Japanese yen, Prof. McKinnon put forward two propositions. First, yen appreciation pushed the Japanese price to a level significantly higher than the level measured by purchasing power parity. As a result, enterprises became unprofitable, which then led to the fall in investment. Second, given the US interest rate, yen appreciation expectations led to the fall in the Japanese interest rate. As a result, the Japanese economy fell into the liquidity trap and made Japan’s monetary policy entirely impotent. For those who are familiar with China’s economic situation, it is easy to see that China’s situation now is very different from what Prof. McKinnon described in Japan. An appreciation-led deflation that McKinnon worried about is not likely to happen in China. Many Chinese economists like to cite the Japanese experience to support their arguments against RMB appreciation. For them, Japanese yen appreciation resulted in serious damage to the Japanese economy. However, it should be pointed out that this explanation of the Japanese experience is not necessarily precise. Despite the view of famous and respected economists such as McKinnon, this opinion is just one view. It is neither widely supported by Japanese economists nor by economists in the circle of international economics. Those who attribute Japan’s economic bubbles and resulting deflation to yen appreciation after the Plaza conference in September 1985 forget that there was another Group 7 conference— the Louvre conference in February 1987. The objective of the Louvre conference was to stop the drastic fall of the US dollar vis-à-vis the Japanese yen and the Deutsche mark. In other words, the objective was to prevent the latter two currencies from appreciating. To accommodate the United States’ wish, the Bank of Japan lowered its benchmark interest rate—its official discount rate—to 2.5 percent, while Germany refused to budge. From a macroeconomic perspective, the main and direct cause for Japan’s bubble economy was its expansionary monetary policy, which was a result of Japan’s fear of the negative impact of yen appreciation on economic growth. Yen appreciation was not the cause of the Japanese bubble economy. In the first half of the 1990s, the Japanese yen appreciated again. This time it was related to the burst of the bubble economy and its consequences. For example, in 1995 due to the worsening of non-performing loans Japanese financial institutions had to withdraw the Japanese yen



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from overseas markets to write off non-performing loans and meet capital adequacy requirements. As a result, the Japanese yen appreciated. In short, the relationship between the change in the exchange rate and the economic and financial situation of a country is complicated. Drawing careless conclusions should be avoided. III. Comments on Proposals for Reducing the Pressure on RMB Appreciation The reality that China currently faces is that due to huge appreciation pressure in order to maintain the RMB’s peg to the US dollar, China’s central bank—the People’s Bank of China (PBOC)—has to intervene in the foreign exchange market constantly by purchasing continuously large amounts of US government securities. At the same time, the PBOC has to implement a sterilization policy to mop up excessive liquidity and stabilize the growth of the monetary base. It is well known that a sterilization operation is costly. While the PBOC has increased its holding of foreign assets, it has to reduce its holding of domestic assets such as government bonds issued by the Ministry of Finance. The returns of its investment on foreign assets must be significantly lower than those on domestic assets. Outsiders would not know what the PBOC’s losses are. What they can know is that the Ministry of Finance eventually has to bear those losses. To make things worse, after many years of a sterilization operation the PBOC sold all the government bonds it once possessed. Under this circumstance, it created a new financial instrument for implementing sterilization operations. This new instrument is called central bank bills (CBBs). The PBOC sells the CBBs to commercial banks and at the same time reduces commercial banks’ excess reserves with the central bank. Because of the reduction in commercial banks’ reserves, their lending ability is reduced correspondingly. So far, the PBOC’s sterilization operation is very successful. But the sustainability of the sterilization operation needs further exploring. To attract commercial banks to reduce excess reserves in exchange for CBBs, the latter must be more profitable and more liquid then commercial banks reserves in the PBOC. This implies that if the PBOC continues the sterilization operation, it will suffer heavy losses. It seems that countries cannot avoid disruptions to the normal functioning of the monetary system through endless sterilization operations. In response to the fact that the RMB is under large appreciation pressure and the central bank cannot implement sterilization policy infinitely, Chinese

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economists put forward many proposals for reducing appreciation pressure while avoiding RMB appreciation. It is fair to say that some of these proposals are feasible, but many more are either unfeasible or will make things worse. One of must popular proposals is to use foreign exchange reserves to buy strategic materials. For the sake of national security, China needs to build up its strategic reserves. However, the building up of strategic reserves and the maintenance of the stability of the exchange rate are two separate matters. Each endeavor has its own objectives and timetable. The former should not be used as a means for achieving the latter. Otherwise, misallocation of resources may occur. For example, the current oil price is 30 dollars per barrel. Assuming that the oil price will fall to 20 dollars a barrel one or two years from now, should China import more oil just for the purpose of alleviating RMB appreciation pressure? Similarly, assuming that China needs to import more grain and if the RMB is under depreciation pressure, should China abandon the plan to import more grain for the sake of avoiding increasing RMB depreciation pressure? There is a view that in order to reduce RMB appreciation pressure China should loosen capital controls significantly and encourage different forms of capital outflow. While all sorts of price distortions are still prevalent, ownership of properties is still not clearly defined, the financial system is still fraught with unsolved problems, and the illegal transfer of assets abroad is still rampant. To promote more radical capital account liberalization for the sake of avoiding RMB appreciation is to put the cart before the horse. When the flexibility of the RMB exchange rate increases gradually, pursuing capital account liberalization in a slow fashion is a correct approach. At present, China should maintain the ban on foreign exchange transactions in spot, forward, and future markets if these transactions are unrelated to current account transactions. Also, the government should maintain a strict approval system for outbound investment by enterprises. But, the government should encourage commercial banks to keep more dollar exchanges for themselves rather than to sell them to the central banks. Some overseas economists and financiers entertain the idea that China should liberalize its capital account while maintaining the dollar peg. This is the worst possible policy proposal, which inevitably will make China lose its policy independence entirely and turn China into an automatic telling machine for foreign speculators. Some economists argue that China should scrap or lower tax rebates for exports. By doing so, not only will pressure for RMB appreciation reduce as a result of fall in exports but it also will alleviate the fiscal burden on the Ministry of Finance. Indeed, some of those trade promotion measures



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should be scrapped. This is a topic worthy of careful and separate discussion. It is worth noting that rebates on value-added tax are a common practice across the world. In principle, tax rebate is not an export promotion policy. On the contrary, it is a measure aimed at giving exporting enterprises the same treatment as non-exporting enterprises. Scrapping the tax rebate will lead to discrimination against exporting enterprises and hence cause market distortion. What is at issue is not the legitimacy of the tax rebate; it is whether or not the rate of tax rebate is rational and how to clamp down on illegal practices such as delaying paying tax and false exports aimed at getting the tax rebate. Certainly, the government should give equal treatment to exporting and non-exporting enterprises. The key point is that while both the reduction of the rates of tax rebate and RMB appreciation can lead to the same result of export reduction, compared with deciding numerous rational rates of tax rebate RMB appreciation is a market instrument much easier to implement. Why should China have to choose a more complicated measure to reduce exports in order to reduce the appreciation pressure rather than simply allow the RMB to appreciate, if both will lead to the reduction in exports anyway? IV. On the Timing of RMB Appreciation Among economists who believe that the RMB exchange rate should be more flexible and that RMB appreciation is inevitable in the long run, many hold that it should be withheld until China finds the optimal time. The concern about timing is understandable. However, economic development is a process full of uncertainty. Whether the timing for implementing a certain policy is optimal or not can only be judged with the benefit of hindsight at the end of history. How can it be known at present whether today is better or worse than tomorrow for allowing the RMB to appreciate? It is argued that now the RMB is under appreciation pressure, hence, at this moment the timing for RMB appreciation is not optimal and China has to wait. Logically, waiting for the optimal time means that China should not take action until there is not a need to take action. Having adopted the managed floating, China should not be too hesitant to de-peg the RMB from the US dollar. As long as it is reasonably certain that a moderate appreciation of the RMB will not have a serious negative effect on the economy, China should allow the RMB to appreciate. Whether timing is good or not can be judged only with the benefit of hindsight. Dithering will lead to the loss of good opportunities.

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One important argument against RMB appreciation concerned with timing is that because China’s financial system is very fragile it has to wait until the system is no longer fragile. Certainly, China’s financial system is fragile, due to the existence of large amounts of non-performing loans. Under this circumstance if the RMB depreciates drastically, a financial crisis may follow. This is the most important reason why the Chinese government refused to devalue the RMB during the Asian financial crisis despite the difficulties caused for exports. If the RMB appreciates in a moderate fashion, there should not be serious negative effects on China’s financial system. On the contrary, appreciation pressure and appreciation expectations will create favorable conditions for China’s financial reforms. Hence, rather than trying to eliminate RMB appreciation expectations, China should encourage these expectations and utilize them to push for more reforms. Indeed, the fragility of the financial system is indeed a major constraint for the flexibility of the exchange rate. Without a developed bond market, it is difficult to establish benchmark interest rates, issue debts denominated in the RMB, and create a forward market for the RMB. Without necessary financial instruments to hedge exchange rate risks, financial and nonfinancial institutions will be vulnerable to exchange rate shocks. However, all these do not constitute a strong argument against a moderate appreciation of the RMB. When the central bank assumes all the exchange rate risks, there will be no incentives either for enterprises to use the instruments no for financial institutions to supply them, and hence there will no any possibility of developing the forward market. V. Trade Surplus and Mercantilism Some Chinese economists like to point out that China’s international balance of payments surplus is mainly attributable to a capital account surplus rather than a trade surplus. The point these economists wish to make seems to be that the RMB exchange rate must be set at a level that can guarantee running a trade surplus for China. This view on the trade surplus and the exchange rate is fundamental and deserves careful ­discussion. Why do all countries engage in foreign trade? The most commonly accepted rationale is that when countries produce in line with comparative advantages, trade will lead to optimal allocation of resources worldwide. However, the important concept is the fact that globally the sum of trade deficits and surpluses of all countries must equal zero. Some



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countries’ surpluses mean other countries’ deficits. For most economists, including Prof. McKinnon, a country’s trade balance is determined by the country’s savings gap. For developing countries, because their income levels are low, their savings are also low. However, because they have a strong desire to catch up with developed countries, their investment levels are high. Developing countries’ internal imbalances must be reflected in their external imbalances—running trade deficits. At the same time because economic growth is still in its initial stage in developing countries, the returns on investment in developing countries are high. As a result, developed countries are willingly exporting their capital to developing countries for higher returns. Thus, developing countries’ capital account surpluses will offset trade deficits. Thus, while being able to achieve higher growth rates than they otherwise would have, developing countries maintain a balance in their international balance of payments. This is the common experience of Hong Kong, South Korea, Taiwan, and Singapore—the Four Asian Tigers. From the perspective of economic growth, ideally, developing countries should run current account deficits and capital account surpluses while developed countries should run current account surpluses and capital account deficits. From the perspective of resource allocation, a country should export products with a comparative advantage and import products for which it does not have a comparative advantage. Theoretically speaking, the stronger the comparative advantage in a country’s specific category, the more intensively the category of export should be exported by the country. The purpose of trade is to improve the welfare of a country. In the long run, the width and depth of the participation of international division of labor by a country is constrained by the trade balance of the country, although in the short-term capital inflows can loosen the constraint. While the amount of exports constrains the amount of imports, the amount of exports should be aimed at the need for imports. Except under specific conditions, creating a trade surplus should not be the reason a country engages in trade. If a country’s trade policy is aimed at creating a trade surplus and the accumulation of foreign exchange reserves, the country will return to oldfashioned mercantilism. To suppress the RMB exchange rate will increase China’s trade surplus—although to what degree is arguable. However, at the same time, China’s terms of trade will worsen: costs for imports will increase in real terms. From the perspective of social welfare and resource allocation, to obtain a persistent trade surplus by currency undervaluation may result in losses outweighing the gains. In fact, enterprises that are efficient do not fear appreciation. RMB appreciation will force some

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enterprises that are inefficient to withdraw from export markets so as to reduce the excessive competition among Chinese enterprises. As a result of the improvement in terms of trade, in value terms, China’s trade surplus might increase rather than decrease. RMB appreciation will increase the motivation of the enterprises for relying on raising productivity rather than on cheap labor to increase competitiveness. At the same time, a stronger RMB exchange rate will encourage enterprises to import more advanced capital goods and technologies. In the long run, a reasonable appreciation of the RMB will lead to acceleration in the technical progress of Chinese enterprises. There is a deeply rooted view in the thinking of the Chinese that China must hold a large amount of foreign exchange reserves and that these reserves have to increase every year. The fact that China now has the second largest holding of foreign exchange reserves has become a national pride. A country should hold an adequate amount of foreign exchange reserves. The main rationales are twofold. The first rationale is to maintain the necessary liquidity for international economic transactions. The second one is to use foreign exchange to intervene in the foreign exchange market to maintain the stability of the exchange rate, which is in contrast to the practice under a floating exchange rate regime where, theoretically speaking, there is no need for intervention in the foreign exchange market. However, the question is whether it is better for China to hold an increasing amount of exchange reserves or not. If the answer is no, what is the correct level of foreign exchange reserves China should hold? Yes, holding more foreign exchange reserves can bring in benefits such as liquidity, safety, and stability. But obtaining these benefits comes at a high cost. This is a matter of cost-benefit analysis. Theoretically, there is an optimal level of foreign exchange reserves. Although it is difficult to determine the optimal level, other countries’ experience can be used as references. Traditionally, a country’s foreign exchange reserves should be equal to three months of imports. According to this criterion, China needs to hold only 88 billion US dollar foreign exchange reserves. China’s actual holding has far surpassed this criterion. However, as a result of learning from the experience of the Asian financial crisis, East Asian countries increased their foreign exchange reserves dramatically. They are increasing their reserves to levels that make them more than comfortable with their ability to fend off attacks on their currencies by international speculators. For example, South Korea is not satisfied with the three months criterion. Korean economists proposed a new criterion of “benchmark minimum level,” which is equal to short-term external liabilities plus local financing



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by overseas subsidiaries plus long-term external liabilities having maturity within one year plus capital outflows from foreign portfolio investment stock.4 Among the total, the largest item is short-term external liabilities, which accounts for some half of the total foreign exchange reserves. The reasons for Korean economists to put forward this criterion are threefold. First, international capital flows are highly unstable. Because South Korea has realized full liberalization of its capital account, it cannot use capital controls to fend off attacks on the Korean won by international speculators. Second, because various problems hinder the South Korean financial system, it is difficult for the South Korean monetary authority to use monetary instruments such as interest rates to punish international speculators who are shorting its currency. Third, currency devaluation is an effective way to deal with the shorting by currency speculators. However, because of the fragility of the domestic financial system and lack of confidence, devaluation may cause a serious currency crisis. As a result, South Korea has to increase its foreign exchange reserves and intervene in the foreign exchange market frequently. Using South Korea’s benchmark minimum level criterion, China’s foreign exchange reserves should not exceed 150 billion US dollars. If it is still not enough, how about doubling this figure to 300 billion US dollars? It should be enough by any measure. Why should China continue to accumulate even more foreign exchange reserves? If China faces major attacks from international speculators, there are two viable options: devaluation as the United Kingdom did in 1992 or the reimposition of capital controls as Malaysia did during the Asian financial crisis. Selling foreign exchange reserves to prop up a domestic currency is a dangerous gamble, which eventually is more likely to end up with a dramatic fall in the currency after the hard-earned foreign exchange reserves have been exhausted. Thailand, Indonesia, and Mexico are cases in point. The reason why China was able to maintain the stability of the RMB during the Asian financial crisis was not that China possesses large foreign exchange reserves. It was because China maintained capital controls. International speculators could not amass the necessary RMBs to launch an attack on the RMB by shorting. In other words, under the managed floating system accumulating a certain amount of foreign exchange reserves is necessary. However, accumulating foreign exchange

4 Park Yung Chul, et al., “Fear of Floating: Korea’s Exchange Rate Policy after the Crisis,” Journal of the Japanese and International Economies 15 (2001): 225–251.

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reserves aimed at defending a currency in the face of major attacks can be risky, ineffective, and costly. Recently, another argument for the accumulation of the large amount of foreign exchange reserves is becoming popular: The Chinese government needs to accumulate a large amount of foreign exchange reserves to deal with the problem of non-performing loans. At the moment, the total amount of loans extended by China’s commercial banks is 16 trillion yuan. Assuming the non-performing loan ratio is 20 percent, the total amount of nonperforming loans of China’s banking system is 4 trillion yuan. If foreign exchange reserves are used to write off nonperforming loans, the central bank has to inject 500 billion US dollars into the banking sector. Some have argued that 350 billion US dollars of foreign exchange reserves are not enough for defending the peg. If foreign exchange reserves are needed for writing off nonperforming loans, it will become difficult to imagine how many foreign exchange reserves China really needs. More to the point is the fact that there are many other options for solving the problem of nonperforming loans. Currently, the Chinese government is using measures that are commonly used internationally such as debtequity swap via asset management companies, commercial banks’ writeoffs with own capital and so on. In the worst case and as a final resort, fiscal means can be used to deal with problems resulting from nonperforming loans. To use foreign exchange reserves to write off nonperforming loans fails to address the root cause of the problem and the costs for solving the problem are too high to be acceptable.5 VI. How to Return to the Managed Floating System Generally speaking, under the market demand and supply-based, unitary and managed floating system, when there is RMB appreciation pressure, the PBOC should allow the RMB to appreciate. However, it is legitimate for the PBOC to intervene in the foreign exchange market to manage the magnitude of the appreciation. The PBOC should not shy away from doing it. At the operational level, the safest way to start de-pegging is to allow the RMB to float around the central parity of 1 US dollar for 8.27 yuan with a band of plus or minus 1 percent or less than plus or minus 3 percent.

5 Later in 2003, the PBOC and the ministry of finance decided to use foreign exchange reserves to increase commercial banks capital adequacy.



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Over time and after accumulating enough experience, China can expend the band to plus or minus 10 to 15 percent. The reason for adopting this approach is that at this moment it is difficult to determine the correct exchange rate. Under managed floating, it is a prudent to gradually enlarge the floating band. If the result proves unsatisfactory, China can return to the peg. There are at least three merits in a moderate appreciation. First, it will send a signal to the rest of the world that as a responsible country, China has taken into consideration the interests of other countries and is making efforts to reduce its trade imbalance against them. Second, it will send a message to the Chinese enterprises that exchange rate risks will increase thereafter and they must be prepared. Third, it kick-starts a return to a managed floating regime, under which enterprises will be able to foster a stronger ability to adapt to the changes in the exchange rate. As a result, when international conditions become unfavorable and the RMB needs to devalue, China will be able to devalue the RMB without worrying too much about its effect on the economy. Generally speaking, China should be able to devalue the RMB whenever it is necessary without having to resist the devaluation pressure until the last minute and to devalue in a dramatic fashion. When the RMB devalues, international public opinion will find it difficult to blame China for the devaluation, because China’s exchange rate regime is a genuine managed floating one. VII. China Should Speed up Its Transformation to a More Balanced Development Strategy The different views on the RMB exchange rate reflect more fundamental differences over China’s development strategy. In the past 20 years, China’s development strategy is characterized by export-and-FDI driven. This strategy was a great success. However, this strategy created many problems for the sustainability of China’s future economic development. Currently, China’s export-to-GDP ratio is more than 20 percent. In comparison, although Japan is supposed to be a country whose economy is based on trade, its export-to-GDP ratio is just about 10 percent. China’s export-to-GDP ratio is also much higher than most developing countries. For an extended period of time, China’s growth rate of exports has been much higher than that of GDP. According to the government plan, in the future China’s growth rate of exports will continue to be higher than that of GDP, which means that China’s openness will increase further. Currently, China’s growth and job creation are increasingly dependent on

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exports. However, as a large exporting country, China’s export markets are too narrow and too concentrated. China exports mainly labor-intensive products; the more China exports, the worse its terms of trade, and hence China has to export more. The fear of appreciation is a reflection of China’s current dilemma. To make things worse, while running a 50 to 60 billion US dollar trade surplus a year, China is also running a large capital account surplus. While the banking system received tens of trillions of yuan in deposits and is troubled by not knowing how to use the funds for investment so as to reduce the huge deposit-lending gap, China has attracted more than 400 billion US dollars of FDI and borrowed 150 billion US dollars in debts. As a result of the twin surpluses, or current account and capital account surpluses, China has accumulated 350 billion US dollars in foreign exchange reserves. In other words, China has lent 350 billion US dollars to the United States. The twin surpluses are abnormal and a reflection of the existence of huge market distortion and misallocation of resources. The purpose of FDI attraction normally is twofold. First, it is to supplement the deficiency of domestic savings. Second, it is to introduce advanced foreign technology and managerial skills. However, in China domestic savings are larger than domestic investment, which means that China must be a capital-exporting country. In fact, the question of whether a country is exporting or importing foreign capital can be answered by looking at the country’s current account. If a country is running a current account surplus, the country must be a capital exporting country and vice versa. Despite the fact that China has attracted large amount of FDI, there is no question whatsoever that China is a capital exporting country. In contrast with developed countries’ capital exports, China’s capital exports take the form of buying US government securities. The yields on US government bonds are low. On average only some are 3 percent. In contrast, the returns and profitability of foreign fund financed enterprises in China are very high. According to Business Week, US firms in China have profitability as high as 13 to 14 percent. Assuming US firms’ return is 10 percent, foreign enterprises’ investment income should be 40 billion US dollars per annum. If foreign enterprises decide to remit all their profits back to their home countries, each year China has to run 40 billion US dollars of trade surplus in order to pay for the profits earned by foreign firms in China. Only by doing so can China maintain the balance of its current account. Fortunately foreign enterprises keep most of their profits in China for reinvestment rather than remit the profits home. In 2002, foreign enterprises remitted only 15 billion US dollars of profits



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home. However, the remittance by foreign enterprises was already quite shocking in the 1990s. The remittance began to stabilize after 1999 while FDI inflows picked up at the same time. In statistics, the reinvestment of profits by foreign-funded enterprises is counted as part of capital inflows. The motivation of reinvestment and that of new FDI inflows are similar. Hence, when the situation becomes unfavorable for China, reinvestment will increase and new FDI inflows will fall at the same time. For example, from 1993 to 1997 China saw an increase in the remittance of investment income and a decrease in new FDI inflows at the same time. More importantly, simple arithmetic shows that, given new FDI inflows, the more the foreign-funded enterprises reinvest their profits, the faster the FDI stock will increase. Following the increase in remittance of investment income, which in turn is as a result of the increase in foreign capital stock in China, China has to run an increasingly large trade surplus to offset the outflows of investment income to maintain the balance of international payments. If some day in the future China is not able to run a large enough trade surplus to offset investment income account deficits, the Chinese economy will lose its autonomy and be hit by currency crisis and financial crisis. During the Asian financial crisis, Malaysia was hit more by a large remittance of investment incomes by foreign investors than by capital flight in the capital account. Certainly, crisis caused by a large remittance on large FDI stocks is merely a possibility. The important thing is to reexamine China’s experience over the past 20 years. Then adjust China’s growth strategy to avoid falling into an embracing situation of running a trade surplus merely to pay for the investment incomes of foreign-funded enterprises in China. Otherwise, the possibility of currency and financial crisis could become a reality. Faced with large FDI inflows and a persistent current account surplus, China must make a difficult choice between two options: translating a capital account surplus into a current account deficit or continuing to run a current account surplus but discouraging capital inflows and encouraging capital outflows. The first option means that the RMB must be allowed to appreciate. The second option requires the government to solve many more complicated problems. Some Chinese economists proposed that the preferential policy for FDI should be scrapped and all enterprises national as well as foreign should be given equal treatment. This proposal is definitely correct. In summary, China’s development strategy characterized by export promotion and FDI attraction over the past 20 years was a great success. However, this strategy is an imbalanced strategy for development and

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hence is unsustainable. China needs to accomplish a transfer from the imbalanced pattern of development to a balanced one as speedily as possible. Hopefully, the controversy over the RMB exchange rate policy will lead to more thorough discussions on the more fundamental problems of the growth pattern.

CHAPTER THIRTEEN

RMB’s Internationalization Under the System of Limited Exchange Rate and Capital Account Control Zhang Bin and Xu Qiyuan* Abstract: This paper makes an analysis of arbitrage activities conducted in Hong Kong’s RMB offshore market and the interaction mechanism between the onshore and offshore markets. The development of the RMB offshore market has been mainly driven by interest and exchange arbitrages. Unlike common carry trade activities, the room for arbitrage activities in the RMB offshore market will not become narrower with the increase of such activities in the context of continuous moderate RMB appreciation under the interventions of China’s monetary authorities in its foreign exchange market. That implies that it is more urgent for China to reform its RMB exchange rate as the RMB offshore market blossoms. Keywords: RMB’s Internationalization, offshore market, arbitrage, carry trade

I. Foreword The Chinese government has taken a series of measures to push forward the internationalization of the RMB in recent years. Especially since July 2009 when the practice of RMB-denominated cross-border trade settlement was launched on a trial basis. In August 2010, Hong Kong’s offshore RMB (CNH) market was set up, and the monthly volume of RMB crossborder trade settlement has rapidly increased to 100 billion yuan. At present, RMB deposits in the Hong Kong offshore market have reached about 600 billion yuan, and the volume of RMB-denominated bonds issued in Hong Kong also exceeded 100 billion yuan in 2011. So far, there have not been systematic studies in domestic academic circles on the RMB arbitrage trading mechanism in the offshore and onshore markets. This paper aims to examine the basic RMB arbitrage logic and facts in the offshore and onshore markets. After in-depth studies, the authors have found that pushing forward RMB-denominated trade * This article was first carried in Guoji jingji pinglun 国际经济评 [International Economic Review] 4 (2012). Zhang Bin is Professor and Head of the department of Global Macroeconomics in the Institute of World Economics and Politics (IWEP) at the Chinese Academy of Social Sciences. His email address is [email protected].

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settlement and developing an offshore market before the marketization of the RMB exchange rate will produce a lot of non-risk arbitrage opportunities. In addition, arbitrage deals that enjoy subsidies from the monetary authorities will dominate RMB businesses in the offshore market. It will also cause substantive repercussions for the onshore market. Under these circumstances, not only will it be difficult to realize the original purpose for pushing forward RMB’s internationalization but also the monetary authorities will also suffer some losses financially, which will add more difficulties to the implementation of their monetary policies. To push forward RMB’s internationalization, China should first promote a full marketization of its RMB exchange rate. The sequence of reform priorities should not be inverted. This paper consists of four parts: (1) an overview of relevant viewpoints; (2) the trading logic in the offshore market; (3) the trading logic in the onshore market; (4) conclusions. II. Overview of Viewpoints Domestic studies of the internationalization of the RMB were first focused on the general analysis of its costs and benefits as well as historical experiences. With the introduction of RMB-denominated trade settlement policies and the blossoming of Hong Kong’s offshore market, the focus of RMB’s internationalization studies gradually shifted to the development of its offshore market as well as interactions between the offshore and onshore markets. 1. Why Set up Hong Kong’s RMB Offshore Market? Why did China open an RMB offshore market in Hong Kong since its development will inevitably challenge relevant monetary regulatory policies adopted by the mainland’s monetary authorities? Explanations are as follows: The establishment of an RMB offshore market will facilitate the internationalization of the Chinese currency. Many scholars, represented by members of the RMB’s Internationalization Research Group under the Boyuan Foundation, believe the opening of an RMB offshore market in Hong Kong follows the general trend of RMB’s internationalization.1 Of 1 Boyuan Foundation Compilation 博源基金会, “Renminbi guojihua: yuanqi yu fazhan 人民币国际化：缘起与发展 [RMB’s Internationalization: Origins and Development],” (Beijing: Social Sciences Academic Press, 2011), 161–173.



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them, He Dong (何东) and Robert McCauley argued foreign speculators usually prefer to make use of the offshore market to increase the position of a targeted currency. Thus, they believe, the development of an offshore market will help increase RMB’s attractiveness to overseas investors and push forward its internationalization. They also pointed out that the development of an RMB offshore market is still feasible even in the context of China’s current capital control. One of the prerequisites, they believed, is that offshore financial institutions must reserve a clearing account in a mainland bank and enjoy a full right for their free withdrawal.2 Therefore, RMB’s internationalization does not necessarily need the opening of capital accounts. Another important factor cited by some who support the opening of an RMB offshore market in Hong Kong is the controllability of risks.3 All steps made by Hong Kong’s RMB offshore market have been under close cooperation between the Mainland’s and Hong Kong’s monetary authorities. The Mainland’s monetary authorities have also always kept a close eye on the development of RMB businesses in Hong Kong. In the context of capital control in mainland China, the opening of an RMB offshore market in Hong Kong is viewed as China’s experimental step toward relaxing its capital control. To promote a double-track internationalization of RMB, a proposal advocated by Li Daokui and Liu Linlin, exactly agrees with the same logic.4 From a practical perspective, the establishment of the offshore market created legal and convenient channels for overseas investors to hold RMB-denominated assets. RMB deposits, RMB-denominated bonds, and other various kinds of RMB products doubled in their scale within a short period of time. However, suspicions also emerged over this trend. Based on the analysis of China’s international investment position (IIP), Zhang Bin pointed out two outstanding problems during this process: (1) China’s

2 He Dong and Robert McCauley 何东、麦考利, “Benguo huobi de li’an shichang: huobi he jinrong wending wenti 本国货币的离岸市场：货币和金融稳定问题 [The Offshore Market of Local Currencies: Monetary and Financial Stability],” in Renminbi guojihua: yuanqi yu fazhan 人民币国际化：缘起与发展 [RMB’s Internationalization: Origins and Development], (Beijing: Social Sciences Academic Press, 2011), 173–205. 3 Ma Jun 马峻, “Renminbi lian shichang: Fengxian keshi guimo kekong zhengce ketiao 人民币离岸市场: 风险可识规模可控政策可调 [Renminbi Offshore Market: the risk is Identifiable, the Volume is Controlled and the Policy is Ajustable],” Foreign Exchange 19 (2011): 14–16. 4 Li Daokui and Liu Linlin 李稻葵、刘霖林, “Shuangguizhi tuijin renminbi guojihua 双轨制推进人民币国际化 [A Dual-Track Advancement of RMB’s Internationalization],” China Finance 10 (2008): 42–43.

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foreign assets have been far larger than its foreign debt; (2) the return on China’s foreign assets has been far below that of its foreign debt.5 To push for the internationalization of the RMB through developing its offshore market will cause China’s foreign assets and RMB liabilities to rise further. At a time when the RMB is still on an appreciating tendency and the real return on China’s foreign assets faces a bleak prospect that will worsen the country’s IIP conditions and cause some losses to welfare. Thus, Zhang argues the marketized reform of China’s RMB exchange rate and the reform of its foreign reserves management system remain a more urgent task than the development of an RMB offshore market and the relaxing of capital inflow restrictions. To promote reforms of the domestic financial system is another viewpoint cited to back up the development of an RMB offshore market. Huang Haizhou, He Dong and Ma Jun, Zhang Ming and Wang Xin all believed that in the context that domestic financial reforms still face some obstructions, RMB’s internationalization or the development of its offshore market will force overdue financial reforms to proceed.6 However, different viewpoints also exist regarding this issue. Based on Japan’s experiences of the development of the yen’s offshore market, Tetsuji Murase asserted that the current RMB offshore and onshore development model will create a new power vacuum and relevant interest groups that, on the contrary, will possibly further postpone domestic financial reforms.7 A study spearheaded by Yu Yongding believes that the development of the RMB offshore market adds new pressures to domestic macroeconomic 5 Zhang Bin 张斌, “Zhongguo duiwai jinrong de zhengce paixu–jiyu guojia duiwai zichan fuzhai biao de fenxi 中国对外金融的政策排序——基于国家对外资产负债表 的分析 [Sequence of China’s Foreign Financial Policies—An Analysis of China’s Balance Sheet Conditions],” International Economic Review 2 (2011): 58–63. 6 Huang Haizhou 黄海洲, “Renminbi guojihua: xinde gaige kaifang tuijinqi 人民币 国际化： 新的改革开放推进器 [RMB’s Internationalization: A New Accelerator of the Reform and Opening-up],” International Economic Review 4 (2009): 5–7. He Dong and Ma Jun 何东、马骏, “Ping dui renminbi guojihua de jige wujie 评对人 民币国际化的几个误解 [Comments on a Few Misunderstandings of RMB’s Internationalization],” China Economic Observer (Boyuan Foundation) 7 (2011), 12–20. Zhang Ming 张明, “Renminbi guojihua: jiyu zai’an yu li’an de liangzhong shijiao 人 民币国际化：基于在岸与离岸的两种视角 [RMB’s Internationalization—Two Angles Based on the Offshore and Onshore markets],” Journal of Finance and Economics 8 (2011): 4–10. Wang Xin 王信, “Renminbi guojihua guocheng zhong de wenti yu shouyi yanjiu 人 民币国际化进程中的问题与收益研究 [A study of theProblems in the Process of RMB’s Internationalization and Its Returns],” Internade 8 (2011): 51–55. 7 Tetsuji Murase, “Hong Kong Renminbi Offshore Market and Risks to Chinese Economy,” Institute for International Monetary Affairs, Newsletter No. 40 (2010).



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management through arbitrage opportunities.8 It also remains unknown whether these pressures can convert into a driving force for the reform of the domestic financial market. Zhang Bin claimed that the marketization of the RMB interest rate and exchange rate, two key reforms of China’s financial system, cannot be encouraged by the development of an offshore market.9 2. Why Has Hong Kong’s RMB Offshore Market Been Booming? Wang Qing believed that enterprises under the motive of profiting from the exchange rate and interest rate differences mainly hold RMB deposits in Hong. Thus, he believed, all these RMB deposits should be regarded as hot money.10 But He Dong believes otherwise.11 He argued the fact that 60 percent of Hong Kong’s RMB deposits are held by enterprises and that all these enterprises are participants of cross-border trade settlement exactly demonstrated that real trade bolstered a majority of cross-border RMB trade settlement and thus cannot be completely viewed as hot money. After analyzing the supply and demand of RMB-denominated deposits, bonds, and stocks in the Hong Kong market and disclosing the carrytrade interaction mechanism between the offshore and onshore markets, Peter Garber believed that RMB appreciation expectation served as a core factor behind the development of the CNH market. Furthermore, longrunning RMB appreciation expectations and a resulting exchange rate gap between its offshore and onshore markets, he believes, will produce some distorted influences on China’s RMB-denominated FDI and trade settlement. In the context of RMB appreciation expectations, RMB-denominated import settlement is in essence a kind of trade to satisfy speculative demands although it reflects real trade activities. In this context, FDI and

8 Yu Yongding 余永定, “Ying zanting chutai renminbi guojihua xin zhengce 应暂停 出台人民币国际化新政策 [A Temporary Ban Should be Imposed on New Policies for RMB’s Internationalization],” First Financial Daily, December 5, 2011, A06. 9 Zhang Bin 张斌, “Xianggang li’an renminbi shichang fazhan de kunhuo 香港离岸人 民币市场发展的困惑 [Bewilderment on the Development of Hong Kong’s RMB Offshore Market],” RCIF Policy Brief No. 2011.069 (2011). 10 Wang Qing 王庆, “Chizilun yu renminbi guojihua ‘池子论’与人民币国际化 [The ‘Pool Theory’ and RMB’s Internationalization],” Caijing 6 (2011), 16. 11 He Dong, 何东, “RMB’s Internationalization,” a speech delivered by He Dong at a roundtable conference on RMB’s internationalizaiton held by the Hong Kong Monetary Authority, Hong Kong, on May 23, 2011.

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cross-border trade settlement both bear the nature of carry trade.12 In addition to Garber’s “carry trade theory,” Yu Yongding also applied the “arbitrage transaction mechanism’’ to explain the decline of funds outstanding for foreign exchanges held by onshore domestic financial institutions as well as the from-surplus-to-deficit change of Chinese banks’ from-bankto-client foreign exchange transactions from October to December 2011.13 In short, there have not been wide differences of opinion among domestic economists about the opening of the CNH market. It is also widely believed that RMB appreciation expectations served as a core factor to bolster the development of the CNH market, and that there have existed a lot of carry-trade and arbitrage transactions in the offshore market. 3. Influences of the Offshore Market on the Mainland The practice of RMB-denominated trade settlement and the opening of Hong Kong’s offshore market gave China’s foreign reserves a remarkable boost. The volume of China’s RMB import settlement has been much bigger than its export settlement most of the time since the adoption of the RMB trade settlement practice and the establishment of the CNH market. The application of RMB for import settlement resulted in a considerable decline in foreign exchange demands on the Chinese mainland. As a result, the net supply of foreign exchanges has been increasing. To maintain a previously set exchange rate level, China’s monetary authorities have to purchase more foreign exchange assets, causing its foreign reserves to soar. There have not been disputes within domestic economic circles on this issue. However, the scales of increased reserves have ­caused controversy because different sources of data and different assumptions have been employed. Some also claim that China’s increased foreign reserves should not be completely blamed on the adoption of the RMB trade settlement policy and the opening of the CNH market because the overseas investors utilized the new channels to replace previous ones to acquire RMB assets.14 12 Peter Garber, “What Currently Drives CNH Market Equilibrium?” (Paper written for the Council on Foreign Relations and the China Development Research Foundation workshop on the Internationalization of the Renminbi, Beijing, China, Oct 31–Nov 1, 2011). 13 Yu Yongding 余永定, “Cong dangqian de renminbi huilü bodong kan renminbi guojihua 从当前的人民币汇率波动看人民币国际化 [Look at RMB’s Internationalization Through Current RMB Exchange Rate Fluctuations],” International Economic Review 1 (2012): 18–26. 14 He Dong and Ma Jun 何东、马骏, “Ping dui renminbi guojihua de jige wujie 评对 人民币国际化的几个误解 [Comments on a Few Misunderstandings of RMB’s Internationalization],” China Economic Observer (Boyuan Foundation) 7 (2011), 12–20.



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China’s monetary authorities have experienced pressure on monetary supply and also sustained some financial losses. For example, to maintain the stability of the domestic exchange rate following the increase in foreign exchange supply, the monetary authorities purchased more foreign exchange, and at the same time they put more money into the market. Through raising domestic banks’ reserve requirement ratio and issuing central bank bonds to retrieve increased monetary supplies, China’s central bank did not feel obliged to increase the supply of the country’s base money although it has been under new pressure for monetary injection. Nevertheless, these practices posed a potential threat to the stability of the country’s monetary policies. Zhang Ming believed they constituted a major threat to the independence of China’s monetary policies.15 From another perspective, however, Zhang Bin (张斌) stressed the financial losses the country’s monetary authorities have suffered.16 The RMB has been on an appreciating tendency and the return ratio of RMB liabilities has been staying higher than that of China’s foreign exchange assets, thus bringing China’s monetary authorities some financial losses as a result of increasing foreign exchange assets and RMB liabilities.17 Capital control remains effective in curbing such negative effects, but the loosening of the ban on RMB trade settlement and the opening of Hong Kong’s offshore market partly resulted in the relaxation of a longestablished capital control. Studies made by McCauley18 and Takatoshi Ito19 show that capital does not enjoy a full freedom of flow between Hong Kong’s offshore and the mainland’s onshore markets serving as an indication that a certain degree of capital account control is still put in place. Yu Yongding asserted that China’s capital control is not invalid, but the RMB trade settlement practice and the opening of Hong Kong’s offshore market offered convenience for capital flow and even further spurred the flow of short-term capital.20 He even believed that relevant policies adopted by China are in essence its move to partly loosen its long-established 15  Ibid. 16 Ibid. 17  Ibid. 18 Robert McCauley, “Renminbi Internationalization and China’s Financial Development Model,” (paper written for the Council on Foreign Relations and the China Development Research Foundation workshop on the Internationalization of the Renminbi, Beijing, China, October 31–November 1, 2011). 19 Takatoshi Ito, “The Internationalization of the RMB: Opportunities and Pitfalls,” (paper written for the Council on Foreign Relations/China Development Research Foundation workshop on the Internationalization of the Renminbi, Beijing, China, October 31–November 1, 2011). 20 Ibid.

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capital flow restrictions. Tetsuji Murase labeled such a policy arrangement as a “dual exchange rates policy,” believing that the gap in RMB’s exchange rates between the offshore and onshore markets, in the context of its appreciation expectations, is in essence the Tobin Tax, a type of cost for the transfer of overseas capital to a country. However, such a tax is targeted at overseas capital inflows. For capital outflow, it contrarily becomes a form of financial subsidy. Thus, Murase claimed, China’s policy arrangement on this has contained a tinge of welfare redistribution.21 The overview of the above policies and practices are only a general account of China’s policy status quo on this issue, over which there still exist huge disputes and controversies. To defuse these disputes, some facts should be further drawn out, and a targeted analysis framework should be built. In the following, we will further clarify the characters and facts of the RMB offshore and onshore markets and analyze their interaction to make clear the influences produce by the RMB offshore market on the mainland’s market. III. Development of Hong Kong’s Offshore Market and Its Trading Logic 1. Main Participants and the Transaction Model: August 2010–August 2011 Main participants of the RMB offshore market include: (1) the Mainland’s and Hong Kong’s import and export enterprises; (2) overseas financial institutions engaging in RMB business; (3) hedge funds; (4) ordinary investors such as Hong Kong residents; Because of their inactivity and limited influences, this paper will not make a separate analysis of such investors. The following are an analysis of the market transaction logic in the context of unilateral RMB appreciation expectations from August 2010 to August 2011: First, the main purpose for the Mainland’s and Hong Kong’s import and export enterprises to use RMB for their trade settlement is to gain profits from its exchange rate gap in the CHN and CNY markets. Since the establishment of the CNH market, the price of RMB at the CNH market costs more than at the CNY market most of the time making it possible for importers to profit from the CNH-CNY exchange rate gap through RMB trade settlement. Garber believed that the overwhelming purpose of such 21 Ibid.



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kind of RMB trade settlement is to gain profits from RMB’s exchange rate differences. In essence, it is a type of settlement deal aimed at meeting speculative demand.22 An analysis of the CNH-CNY exchange rate gap and the payment and receiving ratio of RMB cross-border trade settlement will offer evidence for such a judgment.23 The larger the exchange rate gap of CNH-CNY grows, the bigger the profits foreign trade enterprises will gain from the use of RMB to replace the US dollar for import settlement, and as a result the larger the payment and receiving ratio of RMB cross-border trade settlement increases. Since the third quarter of 2010, the RMB settlement coefficient in these two aspects has been a negative 0.87, indicating the cross-border RMB trade settlement is to a large extent based on their motivations for carry trade and arbitrage. Second, financial institutions engaging in offshore RMB business are mainly banks with the aim of profiting from the spot and forward exchange rate gap as well as interest rate differences between RMB and the US dollar. In the context of RMB’s appreciation expectations, financial institutions in the offshore market usually choose to borrow dollars and buy into RMB in the spot market and at the same time sell RMB and buy into dollars in the forward market. For example, a financial institution borrows 100 million US dollars in the spot market with a 0.8 percent oneyear rate and converts them to RMB at 1:6.4 in the CNH market.24 At the same time, it buys into 100.08 million one-year forward US dollars and sells one-year forward RMB at 1:63. The transaction can bring the agency a profit of 10.36 million yuan, or the equivalent amount in US dollars. If a majority of financial institutions engage in such transactions, it will inevitably push up the prices of spot RMB in the offshore market and hold down its forward prices, which will narrow or eradicate the space of arbitrage. The reasons why such kind of transactions can continuously and over a long period gain profits in the CNH market are as follows: Because of the practice of RMB-denominated trade settlement, RMB can endlessly flow from the Chinese mainland to Hong Kong. In this context, buying into RMB by offshore financial institutions will not obviously push up its spot prices. Despite the fact that the sales of forward RMB by financial institutions can hold down its forward prices, a lot of investors will still 22 Ibid. 23 In proportion to the total export payment. 24 The existence of the CNH market makes it possible for financial institutions to convert dollars to RMB. This only started from August 2010.

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be attracted to buy forward RMB if the margin of its appreciation calculated at this price is widely believed to be lower than the level of its future appreciation. To sum up, the existence of the following three factors makes it possible for offshore financial institutions to continue their above-mentioned arbitrage activities: (1) the practice of RMB trade settlement causes a large volume of RMB to flow to Hong Kong; (2) the development of the CNH market provided financial institutions with access to RMB purchases; (3) interventions in its foreign exchange rate market by the Chinese mainland’s monetary authorities has given rise to oneway RMB appreciation expectations in the market, and financial institutions can sell forward RMB at a price higher than its spot exchange rate. The absence of any of these three factors will make continuous arbitrage activities impossible. Third, by taking advantage of a high leverage ratio, hedge funds have bet on future RMB appreciations. As main participants of the nondeliverable forwards (NDF), hedge funds can buy into or sell forward RMB at a 10:1 or even higher leverage ratio.25 The margin of future’s RMB appreciation can be calculated through the NDF prices of forward RMB, but it cannot accurately reflect market expectations any more. In recent years, the margin of RMB appreciations calculated under such a method has been far lower than widespread market appreciation expectations. For example, the one-year RMB appreciation expectation made by NDF has been about 2 percent, while Bloomberg and Consensus Economics predicted it to be 4 percent. Why have there been such differences? The reason is, as we just mentioned, that financial institutions sell a large volume of forward RMB, which, although at a lower price, can still help them gain “double profits”—profits from exchange rate and interest rate differences. A relatively low NDF exchange rate has still attracted hedge funds. If the margin of RMB appreciation widely expected by the market is far higher than its appreciation margin calculated at the NDF price, there will be big profit-making chances for hedge funds, which, together with a high leverage ratio, will help them to profit substantially. Generally speaking, foreign trade enterprises, financial institutions, and hedge funds formed a complicated and interdependent trade chain in the CNH market from which all of them share profits. In the meantime,

25 HKMA, 2011, “Hong Kong: The premier offshore Renminbi business centre,” http:// www.hkma.gov.hk Sep.



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interventions from the Chinese mainland’s monetary authorities in its foreign exchange market and the ensuing one-way RMB appreciation expectations laid a foundation for a series of above-mentioned arbitrage deals. 2. Main Participants and Profit-Making Models: From September 2011 until Now Since September 2011, the influence of the global financial crisis on the prices of RMB in the offshore market reversed and became cheaper than those in the mainland market. Above analyses indicate that combined transactions of foreign trade enterprises, financial institutions, and hedge funds resulted in the prices of spot and forward RMB in the offshore market. After September 2011, a series of preconditions for RMB arbitrage and carry trade at the offshore market completely reversed and the concrete arbitrage mechanism is as follows: A reversal in RMB appreciation expectations leading to a reversal in hedge funds’ net demands for forward RMB followed by sales of forward RMB by financial institutions at a discounted price; the exchange rate differences causes losses instead of profits. At the same time as an interest rate rise in US dollar loans; the profit margin from its interest rate gap also narrowed, which led to the reduction of their spot RMB position by financial institutions and a resulting decline in spot RMB demands followed by RMB depreciations in the CNH market and finally a decline in RMB import settlement, a rise in its export settlement and the following RMB outflow from Hong Kong. A reversal in RMB’s appreciation expectations was the starting point of all subsequent changes. The following factors could explain the reversal in RMB’s appreciation expectations: (1) With the continuing escalation of the European debt crisis, the rise of risk-dodging sentiments in the international financial market, and the increase of financing costs, the bulk of funds that financial institutions and transnational companies possessed chose to flow back to their own countries. From September 2011 to November 2011, all major Asian currencies except for the Japanese yen declined in their value against the US dollar. Such a depreciation sentiment also spread to the Chinese currency. (2) Following the slackening in external demand in the context of the debt crisis in Europe, domestic demand also remained soft following China’s real estate regulations. In this context, it was widely believed that China’s monetary authorities will stop RMB appreciation. A similar case happened in 2008 during the global financial crisis. (3) Overseas investors showed concern over China’s local debts and its bad bank debts. These problems are not enough to

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cause a hard landing for China’s economy or result in the collapse of its financial system, but they still have caused certain negative effects for many overseas investors. IV. Development of the Onshore Foreign Exchange Market and Its Trading Logics 1. Main Participants and Trading Models: Before August 2008 According to a list of members of the inter-bank spot foreign exchange market, published by China Foreign Exchange Trade Center, direct participants of the onshore spot foreign exchange market include: (1) The People’s Bank of China; (2) more than 170 domestic financial institutions, including commercial banks and policy financial institutions. They accounted for 62 percent of the members of the onshore spot foreign exchange market; (3) large-sized State-owned enterprises (SOEs) and China-based subsidiaries of overseas financial institutions. China’s SOEs mainly include COSCO, COFCO, CNPC, Sinopec, and six other companies, which account for 4 percent of the total number of participants. The China-based subsidiaries of overseas financial institutions mainly include 111 institutions, accounting for 31 percent of the total market participants. They were all participants of the foreign exchange markets that directly engaged in market trading. In addition, the foreign exchange purchases and sales of foreign trade enterprises were realized mainly through the practice of Chinese banks’ from-bank-to-client foreign exchange transactions. Data in this regard indicated that the current account accounted for 90 percent of its total transaction volumes, indicating this business was mainly targeted at foreign trade enterprises. The following are some analyses of the trading activities by some of the above-mentioned market participants: First, to maintain a targeted exchange rate level, the People’s Bank of China had to hold a net purchase of foreign exchange, causing the country’s foreign reserves to soar. Given that a moderate RMB appreciation was far from returning the market to a supply and demand balance, the central bank had to unilaterally buy a large volume of foreign exchange to keep the RMB exchange rate back on a track of moderate appreciation. As a result, China’s foreign reserves rose dramatically. From January 2005 to August 2010, the central bank on average purchased a net 29.5 billion foreign reserves every month.



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Second, through the practice of domestic banks’ from-bank-to-client foreign exchange transactions, ordinary domestic foreign trade enterprises had a net sale of foreign exchanges in the country’s foreign exchange market. In the context of a continuing trade surplus and an FDI surplus, domestic foreign trade enterprises had a declining demand for foreign exchange and thus chose to sell foreign exchange in the market. Statistics show that from January 2005 to August 2010, the average monthly volume of their net foreign exchange sales reached 29.9 billion US dollars. The sale and purchase of foreign exchange by foreign trade enterprises are not only decided by their imports and exports, but are also influenced by RMB appreciation expectations. To gain profits in the context of RMB’s appreciation expectations running high, export enterprises usually chose a foreign exchange settlement in advance, while import enterprises chose to delay purchase of foreign exchange and other enterprises chose to postpone remitting back their overseas profits or increasing their foreign debt and foreign exchange loans to expand their dollar debt and RMB assets. Statistics shows that enterprises’ foreign exchange settlement and purchases had a positive correlation with RMB appreciation expectations. The correlation coefficient is 0.64. Third, domestic financial institutions had a net purchase of foreign exchange in the domestic foreign exchange market. In addition to the business of banks’ from-bank-to-client foreign exchange transactions, domestic financial institutions also had such businesses as foreign exchange depositing and lending, forward foreign exchange trading, and foreign exchange self-operation business as ways to purchase and sell on the foreign exchange market. As the net buyers in China’s foreign exchange market, they had an average net purchase of 2.1 billion US dollars in the country’s foreign exchange market from January 2005 to August 2010. Given that their business was mainly driven by clients, the net foreign exchange position of domestic financial institutions was on a comparatively small scale. Fourth, large-sized SOEs and China-based subsidiaries of overseas financial institutions had a net sale of foreign exchange in the country’s foreign exchange market. As a net seller, they sold a net 1.7 billion US dollars every month in the country’s foreign exchange market from January 2005 to August 2010. Due to their possession of a large number of overseas subsidiaries, these agencies formed a large volume of current or forward foreign exchange cash flows. The transaction data in the foreign exchange market showed that foreign exchange deals from large-sized SOEs and

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China-based subsidiaries of overseas financial institutions remained very active, with a wide margin of upward and downward fluctuations. With the nature of short-term capital flow, their foreign exchange transactions produced crucial influences on China’s foreign exchange market fluctuations. To sum up, the net foreign exchange supply brought by domestic foreign trade enterprises has had some decisive influences on the supply-demand relations of the country’s middle- and long-term foreign exchange market. Nevertheless, large-sized SOEs, China-based subsidiaries of overseas financial institutions, and domestic financial institutions played a crucial role in the short-term supply and demand changes in the country’s foreign exchange market. 2. Main Participants and Trading Models: From September 2010 until Now The loosening of China’s RMB trade settlement restrictions and the establishment of an offshore market in Hong Kong have offered arbitrage opportunities for some traders in the onshore market and also created convenience for short-term capital flows, which noticeably affected supply and demand relations in its foreign exchange market. In the context of unilateral RMB appreciation expectations before September 2011, to use RMB for import settlement could help enterprises gain profits from exchange rate differences in onshore and offshore markets, which caused the volume of RMB import settlement to rise rapidly. In comparison, the volume of RMB export settlement considerably declined. It accounted for less than 20 percent of the average import and export settlement volume. A large-scale RMB import settlement decreased foreign exchange demands in the onshore market and resulted in an increase of their net supply. In response to the increased net supply of foreign exchanges in the onshore market came the equivalent amount of RMB demands in the offshore market from overseas investors. This was in fact equal to offering overseas investors the opportunity to hold RMB assets. The internationalization of the RMB actually meant a relaxation of capital control in China, just as Yu Yongding pointed out.26 An abrupt reversal in the foreign exchange supply and demand relations in the onshore market since September 2011 once again demonstrated the remarkable influences of RMB’s exchange rate fluctuation expectations

26 Ibid.



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in the onshore market. Compared with September 2011, China’s foreign exchange market in October the same year experienced the following changes: (1) The net foreign exchange supply of foreign trade enterprises suffered a drastic contraction. In September 2011, the volume of net foreign exchange sales by foreign trade enterprises was 165.8 billion yuan, and it declined to 20.2 billion yuan in October 2011, a decline of 145.6 billion yuan;27 (2) Large-sized SOEs and China-based subsidiaries of overseas financial institutions changed from a net foreign exchange supplier to a net demanding party. In October 2011, there was a net purchase of 45 billion yuan, increasing by 126.6 billion from September 2011 in terms of the increased net demand; (3) The volume of net purchases by domestic financial institutions increased. The volume was 7.9 billion yuan in September 2011, and it rocketed to 64.5 billion yuan in October, an increase of 56.6 billion yuan. The net foreign exchange supply made by the abovementioned three kinds of agencies—SOEs, China-based subsidiaries of overseas financial institutions, and domestic financial institutions—was 239.4 billion yuan in September 2011, but it drastically declined to 89.3 billion yuan in October of the same year; (4) To maintain a targeted exchange rate level, China’s central bank still had a net purchase of foreign exchange in September, but it shifted to a net sale in October, resulting in a rare decline in the country’s foreign reserves. The main reason for various enterprises and financial institutions to drastically adjust their foreign exchange positions was the abrupt reversal of RMB’s appreciation expectations, or the emergence of its depreciation expectations, after September 2011. Changed expectations not only forestalled all arbitrage trading activities based on previous RMB appreciation expectations but also made prominent the currency misalignments in their balance sheets left over by past arbitrage transactions. In this context, it was unavoidable for enterprises and financial institutions to make major adjustments to their foreign exchange positions. V. Concluding Remarks The introduction of RMB-denominated trade settlement policies and the establishment of an offshore market in Hong Kong created more convenience for overseas investors to hold RMB. Large volumes of RMB flowed 27 The trade surplus in October 2011 was $17 billion, an increase of $5 billion from the average $12 billion during the preceding nine months.

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to overseas regions since the opening of the Hong Kong offshore market in August 2010 and, at the same time, a larger volume of short-term capital has flowed into China. The move by overseas investors to hold more RMB assets can be viewed as an important progress in RMB’s steps toward internationalization. The question is: does China need the influx of shortterm capital in the process of the internationalization of RMB? Without continuous interventions from China’s monetary authorities in the Mainland’s foreign exchange market, increased holding of RMB by overseas investors also would have brought capital inflow and fueled RMB’s appreciation expectations. However, the scale of capital inflow will be automatically offset by a subsequent RMB appreciation. In the process, China’s foreign reserves would not have risen and the monetary authorities’ normal base money injection would not have been affected. However, the current fact is that the monetary authorities of the Chinese mainland still maintain their continuous interventions in the foreign exchange market in a bid to keep the RMB back on the track of moderate appreciation. In this context, overseas investors, by taking advantage of the loosened RMB trade settlement policies and the opening of Hong Kong’s offshore market, can endlessly increase their RMB assets, leaving the possibility for future’s arbitrage trading. At the same time, China’s monetary authorities have to continue buying the increased supply of foreign exchange and put more base money into the market in a bid to maintain an expected exchange rate momentum. With continuous moderate RMB appreciations, the monetary authorities have sustained financial losses following their continuous purchases of foreign exchange and issuance of RMB. The biggest winners during this process are those traders who gained profits from different RMB prices in the offshore and onshore markets, financial institutions that have benefited a lot from different interest rates and the spot and forward exchange rate differences as well as those speculators who bet on RMB’s appreciation. In the context of exchange rate and capital controls, the internationalization of RMB is to a large extent a result of arbitrages from RMB appreciation expectations. China’s monetary authorities have paid a high cost for this, but RMB’s internationalization under the support of such policies still cannot last long. Once there is a reversal of RMB appreciation expectations among overseas investors or in the event of serious turbulence in the international financial market, a large volume of capital will shift holding RMB assets to dollar assets and the internationalization of the RMB will rapidly subside.



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The introduction of RMB trade settlement policy and the opening of Hong Kong’s offshore market can be viewed as China’s move to relax its capital controls, just as Yu Yongding pointed out. However, under an exchange rate formation system that already cannot reflect the basic landscape of market supply and demand, loosening capital control will lead to a bigger effect from speculative capital and threaten domestic macroeconomic stability. The financial crisis in Latin America and Southeast Asian nations should serve as fresh lessons to China; Beijing should take precautions.28

28 Ibid.

CHAPTER FOURTEEN

How Can RMB Become an International Currency? Enhancing the Status and the Role of SDRs in the International Monetary System: Prospects for the Renminbi Joining the SDR Basket Qiao Yide, Xu Mingqi, Li Rui, Ge Jiafei, and Shi Qing* Abstract: The current and instability-prone international monetary system has serious flaws. Reforming the current international monetary system aims at the ultimate goal of global management of global credit. Since it’s not feasible to establish a global central bank or create a new global currency at the current stage, the reform can be carried out through an evolutionary approach, focusing on promoting the establishment of a more balanced multiple currency reserve system, and enhancing the role of SDRs by expanding SDR issuance and improving its function as an international currency. It is promising for the renminbi to be a freely usable currency, and for it to be included in the SDR basket in the IMF’s 2015 review of SDR valuation. Keywords: International monetary system, SDR, reserve currency diversification, renminbi

In the Asian financial turmoil of 1997, most people blamed the countries where the crisis broke out. However, people focused on not only the United States where the global financial crisis of 2008 broke out but also on flaws in the current international monetary system. The current system is a “non-system” established since the collapse of the Bretton Woods system. To be accurate, the current system is a global reserve system with the US dollar, the credit currency of a country, playing the role of the world’s main reserve currency. This paper analyzes the underlying cause of the instability of the current international monetary system, discusses the ultimate goal, the transition methods and the supplementary mechanism to reform the current system; this essay also focuses on obtaining the ideal goal of creating a new super-sovereign currency reserve system through an evolutionary approach of expanding and enhancing the role * The Chinese version of this article was first published in Guoji jingji pinglun 国际经 济评论 [International Economic Review], 3 (2011). Qiao Yide is the General Secretary of the Shanghai Development Research Foundation. His email address is [email protected].

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of SDRs and improving the governance structure of the IMF. It also tries to make clear the short-term and medium-term goals. In addition, this essay analyses the prospects for the renminbi joining the SDR basket in the foreseeable future. I. The Instability of the International Monetary System and Its Underlying Cause 1. Frequent Financial Crises The last 30 years witnessed more than 100 monetary or financial crises of various scales. Although the underlying cause of early crises may not lie in the international monetary system, the instability of the system intensified the crises to some extent, as in, the 1997 Asian financial crisis, and has become one of the major causes of the outbreak of the 2008 global financial crisis. 2. The Instability of the Value of Reserve Currency The Jamaica system differs greatly from the Bretton Woods system in the fact that the former is a floating exchange rate regime. The Jamaica system emphasizes the floating exchange rates but lacks essential international coordination. Exchange rates are entirely decided by countries according to their needs, which frequently results in distortion and high levels of volatility in exchange rates.1 The introduction of a managed floating exchange rate facilitated the exchange rate intervention and the implementation of beggar-thy-neighbor exchange rate policies by the country issuing the international reserve currency. 3. The Worsening Balance-of-Payments’ Imbalances Due to the instability of the international monetary system and the highly conditional IMF financial assistance, developing countries have to resort to large reserve accumulations to respond to the possible impact. The reserve accumulation for self-insurance generates deflationary bias and creates a negative impact on global full employment.2 As the issuing 1 Xu Mingqi 徐明棋, “Guoji huobi tixi quexian yu guoji jinrong weiji 国际货币体系 缺陷与国际金融危机 [The Flaw of the International Monetary System and International Financial Crisis],” Studies of International Finance 7 (1999): 38–44. 2 United Nations, “Report of the Commission of Experts of the President of United Nations General Assembly on Reforms of the International Monetary and Financial



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country of the predominant reserve currency, the United States focused on its domestic needs and implemented long-standing loose monetary policies without taking the responsibility of stabilizing global economy and monetary order, thus expanding its deficit and worsening balance-ofpayments’ imbalances. 4. The Lack of the Lender of Last Resort The IMF, insufficient in funds and autonomy as well as rigid in its methods, can neither take effective precautions against financial crises nor provide effective financial assistance to deal with crises, lacking the competency to take the responsibility of being the lender of last resort. Likewise, the Federal Reserve, which issues the US dollar, the predominant global currency, cannot be the lender of last resort since it is unwilling to take the international responsibility when the domestic interests conflict with global needs. 5. The Widening Gap between the Rich and the Poor The international monetary system may not be the underlying cause of the widening gap between the rich and the poor, but it intensifies the polarization of the rich and the poor to some extent. The instability of the international monetary system forces the developing countries to accumulate large foreign reserves. The reserves are accumulated by transferring resources and wealth in exchange for the bonds issued by countries issuing reserve currencies, such as the United States. The interest rates of these bonds are very low, even close to zero. In other words, the reserves accumulated by transferring resources do not contribute to the economic growth of developing countries; they, in fact, create subsidies from developing countries to developed countries.3 Meanwhile, if the US dollar depreciates, developing countries will be at the risk of suffering substantial losses in capital. An increasing number of facts indicate that there is multi-instability in the current international monetary system. What’s the underlying cause of the instability? Before the introduction of the Bretton Woods system, gold played a central role in the international monetary system and served as System,” http://www.un.org/ga/econcrisissummit/docs/FinalReport_CoE.pdf (Accessed 12 January 2011). 3 J. A. Ocampo, “Building an SDR-Based Global Reserve System,” Journal of Globalization and Development Vol 1: Iss 2, Article 14 (2010), http://www.bepress.com/jgd/vol1/iss2/ art14. (Accessed 9 February 2011).

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means of payment in international trade. During the Bretton Woods Era, the US dollar was pegged to gold. The US dollar, as the representative of gold, together with gold, played a central role in the international monetary system. With the Jamaica Agreement being signed, the US dollar was neither convertible to gold nor the legal benchmark of the international monetary system. Theoretically, the Jamaica system is a multiple currency reserve system; however, the US dollar, in fact, has maintained its predominant role because of the powerful strength of the United States and the path-dependent currency option and net externality of the Bretton Woods system. The US dollar is essentially the credit currency of the United States. As the predominant global reserve currency, the US dollar possesses the characteristics of a global credit currency. However, the Federal Reserve is still in charge of the issuance and management of the US dollar. When domestic interests conflict with global needs, the Federal Reserve faces the choice of putting domestic interests on the priority list or taking global needs into consideration first, which is a vivid manifestation of the well-known Triffin dilemma in the international monetary system. Therefore, the underlying cause of the instability of the international monetary system is that the global credit is still managed by a single country but not a global institution in the era of credit globalization. II. The Ultimate Goal, the Transition Path, and the Supplementary Mechanism of the Reform of the International Monetary System 1. The Ultimate Goal: Global Management of Global Credit The problems in the current international monetary system should be fundamentally solved by changing the current governance structure of global credit managed by a single country into a new international monetary system of global management of global credit with coordination. A global institution is to the disorder in the expansion of global credit what a central bank is to the chaos in the expansion of domestic credit. Before the creation of central banks, bank notes respectively issued and managed by commercial banks were the first substitution of metallic money to circulate throughout a country. The disorderly issuance and circulation of these notes resulted in credit disorder and frequent financial crises, even the disorder of a whole society, at the end of the 19th century. Thanks to the creation of central banks with the exclusive power to issue currency that governments guaranteed, the domestic credit disorder came to an end.



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Now, the international monetary system is a similar case. With the development of globalization, countries all over the world become integrated and closely related, and currencies of major economies start to circulate regionally or globally with the rapid development of international trade and financial transactions, thus, to some extent, expanding credit globally. However, the global expansion of credit and global circulation of sovereign currencies have not been regulated by global issuance rules, thus, causing the instability in the international credit system. Major banks issuing reserve currencies seem to grab global wealth with their special status without taking the responsibility of stabilizing the value of the currency. According to the lessons afforded by the creation and development of central banks, the only approach to fundamentally solve the problems in the current international monetary system should be creating a global central bank to issue and manage global credit, that is, global management of global credit. 2. Transition Path: From the Managed Multiple Currency Reserve System to the Super-Sovereign Currency Reserve System Global management of global credit should be based on the supersovereign currency reserve system, the establishment of which would call for the thorough coordination and cooperation of all countries. However, it is difficult to realize such an ideal goal in the short term under the current international political and economic climate. Therefore, a viable alternative should be creating a managed multiple currency reserve system and gradually transforming it into a super-sovereign currency reserve system through an evolutionary process. Although creating a managed multiple currency reserve system seems to be a suboptimal choice, compared with the direct creation of a super-sovereign currency reserve system, the managed multiple currency reserve system is more suitable to the current political and economic patterns and easier for major economies to accept with less resistance in implementation; thus, making it the most feasible way to realize the ideal goal of the international monetary system reform. Multiple currencies would be the currencies issued by major economies, including SDRs. The SDR is not exactly a currency.4 However, it could function as a means of pricing and play a role in the international 4 Pietro Alessandrini and Michele U. Fratianni, “International Monies, Special Drawing Rights, and Supernational Money,” SSRN working paper, http://papers.ssrn.com/sol3/ papers.cfm?abstract_id=1429482. (Accessed 21 January 2011).

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monetary system just as the European Currency Unit (EMU) does in the European monetary system. Managed would refer to the coordination and cooperation of major countries issuing reserve currencies. At least all of the major currencies, except the US dollar, should be pegged to the SDR, so that they could share the responsibility of the US dollar in the new international monetary system and make the international monetary system more stable. The managed multiple currency reserve system may as well be accepted by the United States because it would not destroy the leading role of the US dollar in the international monetary system. It would enable other reserve currencies to share the responsibility of being international currencies and stabilize the international monetary system together with the US dollar. It would also push the US dollar to take more responsibility to stabilize its value. Meanwhile, it would be helpful to relieve the United States of the troubles under the current international system. A stable international monetary system will also benefit the United States.5 And huge deficit, monopoly position of dollar, and large inflows of capital do not conform to the national interests of the United States any more.6 Under such a system, the US dollar could gradually relieve itself of the external pressure, and the United States could decrease the balance of payments deficit without influencing the supply of the international currency. Although the proposed monetary system would place restrictions on the US dollar to some extent and make it less possible to depreciate according to its own will, generally speaking, the benefits to the United States outweigh the costs. 3. Supplementary Mechanisms: The Regional Monetary Arrangement The regional monetary arrangement would be a good supplement to the managed multiple currency reserve system. As a collective insurance mechanism, the regional monetary arrangement would be beneficial to the stability of the regional monetary system, thus, stabilizing the inter5 Joseph E. Stiglitz and Bruce Greenwald, “Towards A New Global Reserve System,” Journal of Globalization and Development Vol 1: Iss. 2, Article 10 (2010), http://www.bepress. com/jgd/vol1/iss2/art10. (Accessed 9 February 2011). 6 Fred Bergsten, “We Risk Calamity unless China Safely Offloads Unwanted Dollars,” Financial Times, http://www.ft.com/intl/cms/s/0/d8c3ea26-2ed5-11de-b7d3-00144feabdc0 .html. (Accessed 10 February 2011). Fred Bergsten, “We Should Listen to Beijing’s Currency Idea,” Financial Times, http:// www.ft.com/intl/cms/s/0/7372bbd0-2470-11de-9a01-00144feabdc0.html. (Accessed 10 Feb‑ ruary 2011).



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national monetary system. The practice of European monetary integration proves that the regional monetary arrangement would be an effective mechanism to reduce the dependence on the US dollar and the financial system of the United States as well as the effective approach to improve the stability and order of the regional monetary system. Due to the weak economy, developing countries tend to be unstable because of the impact of international capital even under the new international monetary system; therefore, a collective insurance-mechanism is especially necessary for developing countries.7 III. Establishing the Super-Sovereign Currency Reserve System: From the Perspective of Enhancing the Role of SDRs and Reforming the Structure of the IMF The managed multiple currency reserve system could stabilize the current international monetary system through international coordination and cooperation; after all, it is just an expedient measure during the transition period. Eliminating the underlying cause of instability in the international monetary system still depends on establishing and running a super-sovereign currency reserve system. The establishment of the super-sovereign currency reserve system is a manifestation of “global management of global credit” with various proposals. Some of the most popular proposals are: (1) transform the SDR into a super-sovereign reserve currency and reform the IMF into a genuine global bank;8 (2) create a new super-sovereign reserve

7 Edoardo Campanella, “The Triffin Dilemma Again,” Economics Vol 4 (2010), http:// www.economics-ejournal.org/economics/journalarticles/2010-25. (Accessed 21 January 2011). 8 Zhou Xiaochuan 周小川 “Guanyu guoji huobi tixi gaige de sikao 关于国际货币体 系改革的思考 [Reform the International Monetary System],” http://www.pbc.gov.cn/ publish/english/956/2009/20091229104425550619706/20091229104425550619706_.htm.> (Accessed 25 January 2011). Joseph E. Stiglitz and Bruce Greenwald, “Towards A New Global Reserve System,” Journal of Globalization and Development Vol 1: Iss. 2, Article 10 (2010), http://www.bepress .com/jgd/vol1/iss2/art10. (Accessed 9 February 2011). J. A. Ocampo, “Building an SDR-Based Global Reserve System,” Journal of Globalization and Development Vol 1: Iss 2, Article 14 (2010), http://www.bepress.com/jgd/vol1/iss2/art14. (Accessed 9 February 2011). Peter Kenen, “An SDR Based Reserve System,” Journal of Globalization and Development Vol 1: Iss 2, Article 13 (2010), http://www.bepress.com/jgd/vol1/iss2/art13. (Accessed 9 February 2011).

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currency or asset and establish a genuine global central bank.9 The first proposal is based on the existing IMF and SDRs that are currently issued by the IMF. The ideal international monetary system of “global management of global credit” can be created through the reform of SDRs and the IMF with an evolutionary approach. However, the second proposal is a completely new “creation” that hits the major political considerations, such as who will play a predominant role in the new system, how to allocate the power of the new system, and how to determine and allocate the new currency. As a result, it will inevitably face greater political pressure and resistance. Therefore, the first proposal of transforming the SDR into a global currency is obviously more feasible. Enhancing the status and role of SDRs in the international monetary system, transforming the SDR into a super-sovereign reserve currency through an evolutionary process, and reforming the IMF into the “global central bank” is the solution most likely to fundamentally eliminate the instability of the international monetary system, and it is also the ideal evolutionary approach of the reform. Table 14.1 is a suggested roadmap of the international monetary system reform. This essay has already discussed the goals of the reform of the international monetary system, the managed multiple currency reserve system, and the regional monetary cooperation. In this part, this essay discusses how to enhance the status and role of SDRs in the international monetary system through an evolutionary process, including how to transform SDRs and how to reform the governance structure of the IMF.

John Williamson, “The Future of the Reserve System,” Journal of Globalization and Development Vol 1: Iss 2, Article 15 (2010), http://www.bepress.com/jgd/vol1/iss2/art15. (Accessed 9 February 2011). 9 Pietro Alessandrini and Michele U. “Fratianni, International Monies, Special Drawing Rights, and Supernational Money,” SSRN working paper, http://papers.ssrn.com/sol3/ papers.cfm?abstract_id=1429482. (Accessed 21 January 2011). United Nations, Report of the Commission of Experts of the President of United Nations General Assembly on Reforms of the International Monetary and Financial System, http:// www.un.org/ga/econcrisissummit/docs/FinalReport_CoE.pdf. (Accessed 12 January 2011). Joseph E. Stiglitz and Bruce Greenwald, “Towards A New Global Reserve System,” Journal of Globalization and Development Vol 1: Iss. 2, Article 10 (2010), http://www.bepress .com/jgd/vol1/iss2/art10. (Accessed 9 February 2011). Isabelle Mateos y Lago, Rupa Duttagupta, and Rishi Goyal gave another proposal that the reformed IMF would manage a created super-sovereign currency or asset, which can be classified as the latter. Isabelle Mateos y Lago, Rupa Duttagupta, and Rishi Goyal, “The Debate on the International Monetary System,” http://www.imf.org/external/pubs/ft/ spn/2009/spn0926.pdf. (Accessed 20 January 2011).



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Table 14.1. The Action Plan of Enhancing the Role of SDRs and Reforming the Governance Structure of the IMF

The Action Plan of Enhancing the Role of SDRs and Reforming the Governance Structure of the IMF

1

2

Short Term

Medium Term

Long Term

Year 1–5

Year 6–10

Year 11–15

3

4

5

6

7

8

9

10

11

12

13

14

15

Increase the issuance of SDRs regularly Discuss the most effective way of issuing SDRs Adjust the allocation approach of SDRs Enhance the Role of SDRs

Include emerging market currencies in the SDR basket and adjust the weight of each currency Create a substitution account SDR lending Daily interest rate setting Issue SDRdenominated bonds Use SDRs for pricing in international trade, investment and transactions Promote the opening of private SDR accounts and encourage using SDRs

Improve the Governance Structure of the IMF

Make clear the functions of the IMF in managing global currency Found a panel of experts on monetary issues Reform the issuance mechanism of SDRs Adjust the constituencies of the IMF Executive Board Enhance the IMF’s coordination and supervision in operating international reserve assets

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Enhancing the role of SDRs may help serve the following objects: (1) reducing the extent and costs of international reserve accumulation; (2) augmenting the supply of safe global assets and facilitating diversification; (3) and reducing the impact of exchange rate volatility among major currencies.10 The major powers may not be willing to accept the SDR as a new global reserve currency and recognize the IMF as the world’s central bank.11 However, the resistance to the proposal of only enhancing the status and role of SDRs at the current stage will certainly be much smaller. The proposals are as follows:12 1) Issue and Allocate SDRs in a Reasonable Manner (Year 1 to Year 7) (a) Increase the Issuance of SDRs Regularly (Year 1 to Year 5) Expanding the issuance and allocation of SDRs is a precondition for enhancing the status and role of SDRs in the international monetary system. By now, SDRs have been issued only three times since their creation four decades ago. Even after the latest issuance of the equivalent of 250 billion US dollars in SDRs, the outstanding SDRs account for only 4 percent of the global reserves, making it difficult for them to play an important role in the global reserve system. This essay holds that actions should be taken from now on to increase the issuance of SDRs regularly as a basic step to enhance the status and role of SDRs. If the SDR could replace the US dollar as the major international reserve currency, then with the expansion of SDR issuance and allocation, countries in the world will accumulate more SDR reserves, which could reduce the demand for the US dollar reserves and thus ease the imbalances of

10 International Monetary Fund, “Enhancing International Monetary System Stability— A Role for the SDR?”, http://www.imf.org/external/np/pp/eng/2011/010711.pdf. (Accessed 12 February 2011). International Monetary Fund, “IMF Executive Board Concludes the Meeting on Enhancing International Monetary Stability—A Role for the SDR?” http://www.imf.org/external/ np/sec/pn/2011/pn1122.htm. (Accessed 12 February 2011). 11 Robert Zoellick, “A Monetary Regime for a Multipolar World,” Financial Times, http:// www.ft.com/intl/cms/s/0/a5ce4900-3ad0-11e0-9c1a-00144feabdc0.html#axzz2Lh3HnpQC. (Accessed 1 March 2011). 12 The starting and ending times are based on estimates or suggestions. See Table 14.1 The Action Plan of Enhancing the Role of SDRs and Reforming the Governance Structure of the IMF.



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international current accounts.13 The size of annual issuances should be targeted to offset the increase in reserves, and simpler versions of this proposal would have annual issuance fixed at a given rate of say 150 to 300 billion US dollars a year.14 John Williamson believes that the issuance of 457 billion US dollars a year is reasonable, following the same thinking route.15 Obviously, the amount of annual SDR issuances should be equal to the increase in reserves, but the specific amount of increase in global reserves is changing every year, and selecting different periods or different methods of calculation is likely to yield different results. It is not an ideal option to have annual issuance fixed at a given rate in the long run. A clear and rule-based calculation method should be applied to the amount of SDR issuances, and the issuances could be adjusted every 5 years in the same manner as adjusting the currencies and weights in the SDR basket. A precondition for determining the amount of SDR issuances in accordance with the increase in international reserves would be that SDRs replace the US dollar as the main reserve currency. However, in fact, in the process of expanding the proportion of SDRs in the global reserves, the extent that SDRs would replace the US dollar is completely unknown. Before SDRs truly become the main international reserve currency, the suitable amount of SDR issuances might be far less than the global increase in international reserves. The IMF holds that an annual issuance equivalent to 200 billion US dollars could significantly improve the weight of SDRs in the global reserve system. Indeed, even if the amount could be regarded as total neutral, the substantial reserve increases would no longer be dependent wholly on the United States running a continuing current account deficit.16 However, if the amount of SDR issuance exceeds the required SDR reserves, it is likely to exacerbate the problem of excess liquidity. Therefore, according to the principle of prudence, the amount of SDR issuances should only account for a relatively small proportion of the increase in global reserves at the current stage, and then issuances could be expanded 13 International Monetary Fund, “Enhancing International Monetary System StabilityA Role for the SDR?”, http://www.imf.org/external/np/pp/eng/2011/010711.pdf. (Accessed 12 February 2011). 14 Ibid., 2. 15 John Williamson, “The Future of the Reserve System,” Journal of Globalization and Development, Vol 1: Iss 2, Article 15 (2010), http://www.bepress.com/jgd/vol1/iss2/art15. (Accessed 9 February 2011). 16 Ibid.

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gradually in accordance with the idea of turning SDRs into the main global reserve currency. (b) Discuss the Most Effective Way of Issuing SDRs (Year 1 to Year 5) Regular issuance is the simplest way of issuing SDRs.17 The annual amount discussed above is calculated according to regular issuance. SDRs could also be issued quarterly or monthly. However, regular issuance would not be the optimal strategy. The optimal method would have issuance adjusted in a countercyclical way.18 This method could not only meet the increasing demand for reserves but also could smooth the periodic fluctuations in economy. The two approaches can be made complementary, by making regular allocations but withholding them during booms until the world economy goes into a downturn, following present criteria.19 Issuing the whole or parts of SDRs in a downturn could not only avoid unconditional excess SDRs, which might lead to the abuse of SDRs, but also avoid creating substantial global credit and causing liquidity flood in times of global excess liquidity. (c) Adjust the Allocation Approach of SDRs (Year 4 to Year 7) The current SDR allocation is based on the quota system of the IMF. Developed economies, such as the United States and the European Union, which need a limited amount of reserves or are at least not growing rapidly, get a larger share of new allocation, but developing countries, which are eager for reserves to address shocks, can only obtain a smaller share.20 For example, in the 2009 general SDR allocation of 250 Billion US ­dollars, emerging markets and developing countries accounted for about 40 percent 17  United Nations, Report of the Commission of Experts of the President of United Nations General Assembly on Reforms of the International Monetary and Financial System, http://www.un.org/ga/econcrisissummit/docs/FinalReport_CoE.pdf. (Accessed 12 January 2011). J. A. Ocampo, “Building an SDR-Based Global Reserve System,” Journal of Globalization and Development Vol 1: Iss 2, Article 14 (2010), http://www.bepress.com/jgd/vol1/iss2/art14. (Accessed 9 February 2011). 18 United Nations, “Towards a New International Financial Architecture,” Report of the Task Force of the Executive Committee on Economic and Social Affairs of the United Nations, New York, http://www.un.org/esa/ffd/economicgovernance/EC-ESA_ Financial%20Architecture_1999.pdf. (Accessed 9 February 2011). United Nations, Report of the Commission of Experts of the President of United Nations General Assembly on Reforms of the International Monetary and Financial System, http:// www.un.org/ga/econcrisissummit/docs/FinalReport_CoE.pdf. (Accessed 12 January 2011). J. A. Ocampo, “Building an SDR-Based Global Reserve System,” Journal of Globalization and Development Vol 1: Iss 2, Article 14 (2010), http://www.bepress.com/jgd/vol1/iss2/art14. (Accessed 9 February 2011). 19 Ibid., 3. 20 Ibid., 2.



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of the total, including about 7 percent for low-income countries.21 This allocation approach is unreasonable and SDRs cannot play a useful role. Economists offer a lot of reform proposals: (1) give developing countries more allocations, even all allocations;22 (2) place members of the IMF in two categories: advanced countries, and emerging markets and developing countries, and the number of SDRs allocated to each group as a percentage of the total allocation would be determined by the respective demand of each group;23 (3) developed countries lend their SDRs to developing countries. The current allocation is not only unreasonable but also likely to cause divergence in such issues as whether to issue SDRs and in what amounts; so, the G20 and the IMF executive board have to reach consensus and find reasonable solutions through discussion and negotiation. This essay proposes that some transitional arrangements could be made, that is, 80 percent of the annual issuance would be allocated according to the current quota system, and 20 percent of the annual issuance would be allocated as financial assistance from the IMF according to the special needs of the countries facing extreme difficulties. Allocating SDRs to certain countries or certain types of countries will certainly face major political resistance. 2) Include Emerging Market Currencies in the SDR Basket and Adjust the Weight of Each Currency according to Respective Economic Development (Year 2 to Year 6) Nowadays, the emerging countries have played an increasingly important role in the global economy while developing economies contribute about half of the global growth.24 In order to be more legitimate and attractive as the global currency, SDRs should include the currencies of emerging market countries in the SDR basket and appropriately adjust the weight of each currency according to the economic development. The not-fully convertible currencies of emerging market countries could also be considered to be included in the SDR basket before extending SDRs to the private sector, and it would make emerging market countries play a role in the international monetary system and promote financial maturity in emerging markets and the free convertibility of their currencies.

21 International Monetary Fund, “Special Drawing Right (SDR) Allocations,” http:// www.imf.org/external/np/exr/faq/sdrallocfaqs.htm. (Accessed 21 March 2013). 22 Ibid., 2. 23 Ibid., 15. 24 Ibid., 11.

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3) Create a Substitution Account (Year 2 to Year 5) Creating a substitute account is another approach to increase the supply of SDRs. Central banks would be allowed to deposit a portion of reserves in exchange for SDRs and exchange SDRs into reserves in times of need. Holding reserves in SDRs could make the value of reserves more stable; if there are not any other costs, this proposal could be agreed and accepted by developing countries and countries with large accumulations of reserves. However, this proposal was considered in the 1970s and eventually rejected. The main reason for the rejection of creating a substitution account in the 1970s was that there existed divergence on who should bear the exchange rate risk. In other words, who would and how to keep the substitution account financially sound and stable. Substitution Account Reserve Fund (SARF) is a possible solution to the problem mentioned above. The IMF charges an annual fee equal in total to a certain percent of the number of dollars in the substitution account and deposit it in a SARF. Whenever the number of dollars, including accumulated interest, in the substitution account fell short of the dollar value of the SDR claims on the account, dollars previously deposited in the SARF would have been used to top up the dollar holdings of the substitution account. If the number of dollars held by the SARF were insufficient for this purpose, the SARF would be entitled to borrow dollars from the IMF, repaying them in due course with the proceeds of the annual fees paid thereafter to the SARF.25

Peter Kenen calculates that an annual fee equal in total to one percent of the number of dollars in the substitution account would be sufficient to maintain the financial integrity of the SARF over the 29-year period.26 However, there is not any interest if foreign exchange is deposited in the substitution account, and the charge of an annual fee will make the substitution account less attractive. Only when the risks of the exchange rate volatility of major reserves outweigh the costs may the substitution account be attractive. Therefore, this essay proposes that countries issuing reserve currencies issue SDR-denominated bonds to the IMF to provide funds deposited in the substitution account with stable proceeds.

25 Peter Kenen, “An SDR Based Reserve System,” Journal of Globalization and Development Vol 1: Iss 2, Article 13 (2010), http://www.bepress.com/jgd/vol1/iss2/art13. (Accessed 9 February 2011). 26 Ibid.



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4) Broaden the Scope of Using SDRs (Year 2 to Year 15) (a) SDR Lending (Year 2 to Year 3) In order to support the IMF assistance mechanism, IMF members would be encouraged to individually or jointly lend surplus SDR positions to those who need financial support. It would be an important approach for existing SDRs to play a key role without expanding SDR issuance. The countries with surplus SDRs could gain interest while their counterparts could exchange SDRs into convertible currencies to solve various problems. (b) Daily Interest Rate Setting (Year 2 to Year 5) The current SDR interest rate is set weekly and is based on a weighted average of representative interest rates on short-term debt in money markets of the four constituent currencies. Setting the interest rate daily would encourage reserve managers to take SDRs as reserves, promote the development and maturity of the SDR bond market, and improve the attractiveness of SDRs as an international reserve currency. (c) Issue SDR-Denominated Bonds (Year 3 to Year 4) In order to make the SDR an attractive reserve currency, SDR-denominated bonds should be issued and the SDR bond market should be refined. At the initial stage, currencies of sovereign countries could settle SDRdenominated bonds. The value of SDRs would be more stable and the original currency could still settle SDR-denominated bonds, which would benefit the development and progression of the SDR bond market. With the improvement of the status and role of SDRs in the international monetary system, these bonds would gradually switch to be settled by SDRs. The IMF could issue these bonds as well as other countries or institutions. Since the value of SDRs would be stable, SDR-denominated bonds would be more attractive to small countries with unstable currencies. The IMF could play an important role in the SDR bond market. SDRdenominated bonds that the IMF issues could help establish a benchmark yield curve to facilitate the pricing of SDR-denominated bonds issued by other institutions. The IMF would be a low-credit risk issuer since its liabilities are backed by quota resources.27 In addition, instead of relying entirely on quotas of its members, the IMF could issue SDR-denominated bonds to broaden the sources of funds.

27 Ibid., 13.

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The support of other official institutions would be conducive to the rapid development and successful operation of the SDR bond market, including the commitment to issue and invest in SDR-denominated bonds. The issuance of SDR-denominated bonds by official institutions would be conducive to the pricing and issuing of private SDR-denominated bonds. In addition, investments in SDR-denominated bonds would be safer than investments in any other sovereign bonds, since exchange rate risks could be averted and higher liquidity could be obtained with the development of the SDR bond market. At the initial stage, the SDR bond market would be subject to a higher risk premium because of the lack of market depth. Therefore, it would be better to issue SDR-denominated bonds by several countries jointly to improve the liquidity of the market and lower the premium as soon as possible. (d) Use SDRs for Pricing in International Trade, Investment, and Transactions (Year 7 to Year 10) Transactions in home currencies could help countries secure income in international trade, but it would be inefficient in global trade practice. Using SDRs for pricing in international trade could avert the exchange rate risks to some extent and promote the development of the SDR bond market, and an SDR bond market with better liquidity would in turn promote SDRs to be more acceptable in pricing. Multinational companies could use SDRs for pricing in accounting practice to facilitate international comparisons. The IMF could encourage countries to use the SDR as the account unit of the balance of payments. At the initial stage there would be a larger cost to use SDRs, so the international reserves, which cost the least, could be the first to use SDRs in bookkeeping. Multinational institutions could also consider using the SDR as an account unit. For example, the Bank for International Settlements (BIS) has used the SDR as its unit of account since April 2003. (e) Promote the Opening of Private SDR Accounts and Encourage Using SDRs in International Trade and International Financial Markets (Year 11 to Year 15) As the SDR increases its weight in international reserves and is widely used as a measure of value, it can be pushed to the private sector, allowing private SDR accounts to open, and encouraging the use of SDRs for international pricing and settlement.28 With the development of SDR 28 Peter Kenen, “Use of SDR to Supplement or Substitute for Other Means of Finance,” in International Money and Credit: The Policy Roles, ed. George M. von Furstenberg, (Washington D.C.: International Monetary Fund, 1983): 327–360.



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bond market, the stability of the value of SDRs, and the facility of holding SDRs, SDR-denominated assets would be more attractive to individuals and private agencies. This would make the transition more costly for the United States, and it is therefore likely to face greater resistance from the United States.29 However, being pushed to the private sector could make the SDR a genuine currency. The functions of settlement and pricing in SDRs are complementary.  In addition, after pushing SDRs to the private sector, central governments could directly use SDRs in economic intervention or other economic affairs instead of having to exchange SDR holdings into other currencies, so that the SDR would become more attractive as a reserve currency. At the same time, SDRs in the private sector would also be conducive to the development and deepening of the SDR bond market. 2. Improve the Governance Structure of the IMF With SDRs becoming the genuine global currency, the IMF, the organization most likely to manage the global credit as a global central bank would need necessary reforms to adapt itself to the change and play a more important role in the new international monetary system. 1) Make Clear the Functions of the IMF in the Supervision of International Finance and the Managing Global Currency (Year 2 to Year 5) To improve the governance structure of the IMF and transfer the IMF into global central bank, the functions of the IMF in the supervision of international finance and the management of global currency should be made clear. In a sense, not having a global government means not having a global central bank, thus not having a global currency; however, an effective quasi-central bank could be established to manage the global credit through the cooperation and coordination among major powers. 2) Found a Panel of Experts on Monetary Issues (Year 2 to Year 6) A panel of experts on monetary issues could be founded in order to make SDR issuances more reasonable. Monetary experts and presidents of central banks of countries issuing reserve currencies would constitute this group and offer their independent opinions to the IMF executive board on global liquidity issues, including issuing SDRs and canceling the ­issuance

29 Ibid., 3.

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of SDRs. The group would play an important role in improving the issuance mechanism of SDRs. 3) Reform the Issuance Mechanism of SDRs to Meet the Need of Global Economy Rebalancing (Year 4 to Year 7) The current issuance mechanism lacks a regular pattern and is unable to reflect the different needs for SDRs among different countries. In reforming its governance structure, the IMF should lead the reforming process of the SDR issuance mechanism, coordinate all forces, and form the management framework of the issuance to make SDRs, as the global reserve currency, better reflect the needs of the global economic rebalance. 4) Adjust the Constituencies of the IMF Executive Board to Reflect the Status of Emerging Market Countries in the World Economy (Year 4 to Year 7) The current constituencies of the IMF executive board cannot reflect the rapid economic development of emerging market countries and does not play an effective role in encouraging emerging market countries to stabilize the international monetary system. It would be necessary to gradually adjust the constituencies of the IMF executive board to reflect the status of emerging market countries in the world economy. 5) Enhance the IMF’s Coordination and Supervision Abilities in the Operation of International Reserve Assets (Year 8 to Year 11) Countries issuing reserves hope that other countries hold the international reserves steadily and do not sell off reserves on a large scale, which may cause high levels of volatility in the value of the reserve currencies. At the same time, countries holding reserves also hope countries issuing reserves take the needs of the world into consideration and keep the stability of the value of the reserve currencies when making monetary policies. Obviously, countries issuing reserves and countries holding reserves share common interests and hope the counterpart will take on major responsibilities. Under this circumstance, the IMF could intervene appropriately and enhance the coordination and supervision in the operation of international reserve assets.



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IV. Prospects of the Renminbi Joining the SDR Basket: The Renminbi Expected to Be Included in the SDR Basket in IMF’s 2015 Review The World Bank estimates three scenarios for the future international monetary system in 2025. The three scenarios are as follows: (1) dollar standard status quo; (2) a system with three equally important currencies, that is, the US dollar, the euro, and the renminbi; (3) a system with a single super-sovereign reserve currency, that is, the SDR. The second scenario is the most likely to play out while the third is the least likely one over the next 15 years.30 This essay agrees with the World Bank on this issue. Given the current trends, the renminbi internationalization will play a positive role in pushing the international monetary system to evolve into the second or the third scenario. As far as time is concerned, we need to focus the attention on whether it is possible for the renminbi to join the SDR basket in the foreseeable future or not. The value of the SDR is defined as a basket of currencies, and the SDR basket composition is reviewed every five years.31 Whether or not the renminbi is qualified to be included in the SDR basket in IMF’s 2015 review can be analyzed in accordance with the IMF’s criteria, the current situation, and prospects of the renminbi. 1. The Current Criteria of the SDR Basket Currencies In accordance with the IMF’s criteria, “the composition of the SDR basket reflects the following criteria: the SDR basket comprises currencies that are issued by Fund members (or by monetary unions that include Fund members), whose exports of goods and services during the five-year period ending 12 months before the effective date of the revision had the largest value, and that have been determined by the Fund to be freely usable currencies”32 (see Figure 14.1).

30 World Bank, “Global Development Horizons 2011—Multipolarity: The New Global Economy,” http://siteresources.worldbank.org/INTGDH/Resources/GDH_CompleteReport 2011.pdf. (Accessed May 5, 2012). 31 The IMF reviews the valuation of the SDR every five years and prepares Review of the Method of Valuation of the SDR, which reviews the valuation of the SDR, the selection and weighting of currencies in the SDR basket, the SDR interest rate etc. 32 International Monetary Fund, “Review of the Method of Valuation of the SDR,” http://www.imf.org/external/np/pp/eng/2010/102610.pdf. (Accessed April 10, 2011).

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Widely used to make payments for international transactions

The SDR basket

The currency denomination of official reserve holdings

Freely usable currencies The volume of transactions

Widely traded in the principal exchange markets

The exsitence of forward markets The spread between buying and selling quotations for transactions denominated in that currency

Figure 14.1. The Criteria of the SDR Basket Currencies

In accordance with Articles of Agreement of the International Monetary Fund, Article XXX (f ), “A freely usable currency means a member’s currency that the Fund determines is, in fact, widely used to make payments for international transactions, and is widely traded in the principal exchange markets.”33 The IMF provides more detailed criteria for determining which currencies are freely usable: The assessment of the use of a currency for international transactions should be based on the extent to which trade in goods and services is paid for in that currency, as well as on the relative volume of capital transactions denominated in that currency. Given the limited data availability, however, the staff suggested to use the shares in members’ exports of goods and services and the currency denomination of official reserve holdings as the relevant indicators of the degree to which a currency was widely used in international payments; the assessment of whether a currency was widely traded in the principal foreign exchange markets should be based on the volume of transactions, the existence of forward markets, and the spread between buying and selling quotations for transactions denominated in that currency. A sufficiently deep and broad foreign exchange market was considered as being necessary to ensure that a member country would be able to sell or buy a sizable amount of the currency.34

In accordance with By-laws, Rules and Regulations of the International Monetary Fund, O-3, “The Fund shall determine the currencies that are 33 Ibid. 34 Ibid.



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freely usable in accordance with Article XXX (f ).” and “The Fund shall consult a member before placing its currency on, or removing it from, the list of freely usable currencies.” The current criteria reflects that the SDR basket currencies should be both representative in the international trade system and the international financial system, which means they should be widely used in both international trade and finance. 2. The Possibility of the Renminbi Joining the SDR Basket While the emerging markets gradually increase their share in the world economy, the existing SDR basket currency, that is, the US dollar, the euro, the Japanese yen, and the pound sterling, issuers show a declining trend in their share. The current SDR basket is getting less representative of the world economy. Including the emerging market currencies in the SDR basket will improve the structure of the basket and make it more representative to objectively reflect the current situation of the world economic structure. Given factors, such as the economic aggregate of the country, the renminbi is one of the currencies which are closest to the criteria of SDR basket currencies among the potential component currencies from emerging markets. 1) Full Convertibility Is Not the Prerequisite to Join the SDR Basket It is a mistake to think that freely usable currencies should be fully convertible, thus, claiming that being fully convertible should be a prerequisite for including the renminbi in the SDR basket. Timothy Geithner, the US Secretary of the Treasury from 2009 to 2013, stated that the SDRbasket-currency-issuing countries “should have flexible exchange rate systems, independent central banks, and permit the free movement of capital flows.”35 Aleksei Kudrin, Russia’s Minister of Finance from May 2000 to September 2011, believed if the renminbi were to be included in the SDR basket as a non-fully-convertible currency, it was just an exception, and China should provide a clear timetable to show when the renminbi would be fully convertible.36 Compared with the Articles of the IMF, the concept of “freely usable” is misunderstood and people tend to confuse the concept of “freely usable” and “fully convertible.” The IMF has clearly

35 Timothy Geithner, “Statement by Secretary of the Treasury Tim Geithner” (speech presented at the High-Level Seminar on the International Monetary System, Nanjing, China, March 31, 2011). 36 Remarks by Kudrin, the Russian finance minister, during the group seminar at the G20 High-Level Seminar on the International Monetary System in Nanjing.

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stated that, “the concept of a freely usable currency concerns the actual international use and trading of currencies, and is distinct from whether a currency is either freely floating or fully convertible.”37 In fact, opening the capital account is not required in Articles of Agreement of the International Monetary Fund. In practice, the Japanese yen was not truly fully convertible when it was included in the SDR basket as a freely usable currency. Therefore, that full convertibility should be a prerequisite for including the renminbi in the SDR basket does not conform to the current criteria of the IMF and should not be an obstacle in the way of including the renminbi in the SDR basket. 2) The Renminbi Meets the Criterion of “Leading Exporters” for the Inclusion of a Currency in the SDR Basket In accordance with the IMF’s current criteria for the inclusion of a currency in the SDR basket, the renminbi meets the first criterion, that is, China has been on the list of top exporters of goods and services during the past fiveyear period. In “Review of the Method of Valuation of the SDR of 2005,” the IMF already noticed China’s fast economic development. China’s (including Hong Kong SAR) exports of goods and services surpassed that of Japan in 2003, and China became the fourth largest exporter, next to the euro area, the United States, and the United Kingdom. During the years 2005–2009, China’s (including Hong Kong SAR and Macau SAR) exports of goods and services remained the third, behind the euro area as the first and the United States as the second.38 In addition, under the current economic climate, China’s status as a leading exporter will continue to grow steadily. Therefore, the renminbi meets one of the criteria for the inclusion of a currency in the SDR basket: The renminbi’s issuing country China has become one of the leading exporters. That’s why the renminbi would be a candidate for inclusion in the SDR basket, and the IMF used a lot of space in “Review of the Method of Valuation of the SDR of 2010” discussing whether the renminbi would meet the criteria for the inclusion in the SDR basket.

37 In December 1980, the Japanese government revised Foreign Exchange Law, transferring the convertibility principle of Japanese yen’s capital account from restrictive convertibility to releasing control. 38 In “Review of the Method of Valuation of the SDR (2010),” the IMF stated that even if exports of Mainland China alone are considered, China would remain among the top four exporters.



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3) There Is a Gap between the Renminbi and a “Freely Usable Currency” The inclusion of the renminbi in the SDR basket mainly depends on whether or not the renminbi meets the criteria to be a freely usable currency. In accordance with Articles of Agreement of the International Monetary Fund, a freely usable currency is widely used to make payments for international transactions and is widely traded in the principal exchange markets. At the current stage, there is a gap between the renminbi and a freely usable currency, mainly because the renminbi is not widely used in international financial transactions. The renminbi is less than 0.2 percent of the international official reserve holdings. The renminbi accounts for 0.19 percent of international banking liabilities.39 Only 0.06 percent of the international debt securities were denominated in renminbi between June 2005 and December 2009. Renminbi transactions accounted for only 0.1 percent of total turnover in global foreign exchange markets from 2007 to 2010.40 The renminbi turnover is relatively small compared with its import and export activities. For example, in 2009 the ratio of annualized renminbi turnover in foreign exchange markets to international trade (exports plus imports) was 3.0, while the ratio for the Hong Kong dollar was 30.9 and for the US dollar was 270.0.41 In the 2010 review, the IMF pointed out that the Chinese government had made efforts to facilitate the international use of the renminbi; however, at this stage, the renminbi was not widely used to make payments for international transactions, or widely traded in the principal exchange markets, so it would not appear to meet the criteria under the Articles of Agreement for being determined by the IMF to be a freely usable currency and would not be included in the SDR basket.42 However, the renminbi is getting closer to the criteria for freely usable currencies. In recent years, the Chinese government has taken a number of measures to facilitate the international use of the renminbi, including promoting cross-border settlement in renminbi, promoting the People’s Bank of China signing currency swap agreements with other central banks or monetary authorities, allowing banks outside the Chinese mainland to 39 Yi Gang 易纲, “Guanyu SDR huobi lanzi de sikao 关于 SDR 货币篮子的思考 [On the SDR basket],” Unpublished PPT, May 2011. 40 Ibid., 32. 41 Chen, Xiaoli and Yin-Wong Cheung, “Renminbi Going Global,” HKIMR working paper, No. 08/2011, http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1797464 (Accessed 19 May 2011). 42 Ibid., 32.

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enter the mainland’s interbank markets, allowing institutions outside the Chinese mainland to issue renminbi-denominated bonds on the Mainland, allowing institutions in the Chinese mainland to issue bonds outside the Mainland. With an appropriate economic base, reasonable policies, and steady promotion from the government, the renminbi will be internationalized substantially and will meet the criteria for freely usable currencies in the foreseeable future. In the 2015 review, it will be promising for the renminbi to be determined by the IMF as a freely usable currency and to be included in the SDR basket. According to Hayek, “. . . the present necessity ought to be no concern of the economic scientist. His task ought to be, as I will not cease repeating, to make politically possible what today may be politically impossible. To decide what can be done at the moment is the task of politician, not of the economist . . .”43 The task of the politicians is distinguished from that of the economists. However, isn’t it better if the economists can make it both economically and politically possible? With such a faith, this essay puts forward the proposal for the reform of the international monetary system and hope that it can be realized at least earlier than Hayek’s denationalization of money.

43 Friedrich August Von Hayek, Denationalisation of Money: The Argument Refined-An Analysis of the Theory and Practice of Concurrent Currencies (London: Institute of Economic Affairs, 1990).

Part FIVE

Roundtable Forum

CHAPTER FIFTEEN

China and the United States in the Next Decade Zhang Weiying, He Huaihong, Huang Haizhou, Yuan Yaxiang and Wang Jisi* Abstract: What does the future hold for China and the United States in the next decade? Will the United States decline? How will China-US relations evolve? What are the challenges for China and the United States respectively? What kind of expectation can we have? This article discusses these questions from the different perspectives of experts and scholars on international relations, politics, economics, culture, science, and technology. Keywords: China and the United States, relations, challenges, outlook

I. US Decline is Unlikely in the Next 10 Years Wang Jisi (the School of International Studies, Peking University) No evidence indicates that the United States will decline in the coming ten years. Today I am happy to participate in the debate on the rise and decline of the United States. This topic was discussed more than a decade ago when the argument for the possible decline of the United States was first raised. Since 2008, this view has been back in the news and deliberated * The Chinese version of this article was first published in Guoji jingji pinglun 国际经 济评论 (International Economic Review) (3) 2011. This article was originally presented as a roundtable discussion and therefore does not follow the usual academic format with regard to citations and attributions. If the readers have any questions, we encourage them to contact the original authors. Zhang Weiying is Professor of Economics in the Guanghua School of Management at Peking University as well as Director of the Market Network Economic Research Center at the same university. He is also the Chief Economist of the China Entrepreneurs Forum. His email address is [email protected]. He Huaihong is Professor of Philosophy at Peking University and Director of Ethics Teaching and Research Office. His email address is [email protected]. Huang Haizhou, [email protected]; Yuan Yaxiang is Academician of CASS where he is also Professor in the Academy of Mathematics and Systems Science as well as in the Institute of Computational Mathematics and Scientific/Engineering Computing. He is also a member of the Society for Industrial and Applied Mathematics (SIAM) and a member of the International Institute of Mathematical Programming. His email address is [email protected]. and Wang Jisi, [email protected].

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in the international community with most people believing the decline of the United States is possible and a few thinking otherwise. This is similar to the previous debates, and this time, voices calling out the American decline are even louder than ever before. First, the rise and decline of the United States in the future is a political thesis but not an academic one. Some pessimistic assessments on the future of the United States are not free from personal subjective or even political biases, for whether a commentator holds a favorable view of the United States or whether his or her interests are affected by the decline of the United States would surely influence his or her judgment. This certainly does not mean that their opinions are not important. However, it is important to take into consideration the effect of “a self-fulfilling prophecy” when discussing this topic, for when a broad consensus is reached that the United States is about to decline, it might come true. It should be noted that with regard to the rise and decline of the United States people have different opinions, which arise out of different motivations. Some people think that the United States will be able to maintain its current preponderant position, which I call the prosperity school, and the opposite view can be called the declinist school. It is particularly noteworthy that very few people now believe that the United States will become stronger than before; it can at best maintain its current position. Very few people held such a view in the previous debates. The declinists roughly fall into two groups: those who have a very unfavorable view of the United States and those with a crisis mentality intending to alert the United States to its current domestic challenges.1 Sometimes the latter will urge the United States to guard against its complacency and continue to forge ahead by highlighting China’s rapid ascent. These opinions should be given attention because these stances may affect the resulting conclusions. The second point is related to the reference points to make in examining the rise and decline of the United States. Even if the United States is compared with its own past, it should also be taken into account with which period it is compared. For instance, the period between Nixon and Carter was the darkest one in the post-war American history, and the United States today is definitely much stronger than that of the 1970s, be it economic strength or overall national image. For another example,

1 The declinist: 这种表述参见: Michael Beckley, “China’s century? Why America’s Edge Will Endure,” International Security, Vol. 36, No. 3 (Winter 2011/12), pp. 41–78.



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during the Clinton era, the United States rose to the height of its power, an era unmatchable by today’s United States in any aspect. During the early part of the George W. Bush era, the United States still enjoyed some political and economic legacy of the Clinton era while the later part was plagued with such problems as the financial crisis and the quagmire of the Iraq War. So, if compared with the Bush era, the United States today does not do as well as the early period of the Bush administrations, but certainly does far better than the later period. When compared with other countries, it is important to consider with which country the United States is compared. If compared with Europe or Japan, the current situation of the United States is much better. However, compared with some emerging countries, the American position in the world is in a relative decline. What is new about the latest debate on the rise and decline of the United States is that emerging countries such as China, India, and Brazil are frequently referred to when making comparisons, with China as a focal point. However, the focus of the current debate is not about the change of the United States’ relative position to these countries. If we carefully examine these other countries, we will find that none of them really possess the potential to overtake the United States in all aspects that constitute the power a country has in a global context. After all, the United States enjoys unique advantages in the natural endowment and the openness of society. For instance, while it is possible for anyone to become a US citizen if he or she wishes, it is almost impossible for a foreigner to become a Chinese citizen. They can hardly be accepted in Chinese society even they have obtained Chinese citizenship. From this perspective, the United States is in a better position to become a world power. Another new feature of the current debate is that it is triggered by the financial crisis. The United States was hit so hard by the financial crisis that many people thought that the capitalist development model or Washington Consensus was outdated, and thereby should be replaced by China’s development model or Beijing Consensus. A sub-topic of this argument also includes the doubt about the US dollar as the dominant international currency and the US financial predominance in the world. Militarily the US hegemony is rarely questioned because its military primacy is still widely recognized. President Clinton once said that it is only a matter of time for other countries to catch up with the United States in economic strength, and the United States should establish a set of international rules before its decline if it wants to maintain its living standards and leading position in the world. However, it is quite another

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thing for other countries to overtake the United States as the leading military power. The target country that the US considers and worries about is no longer Germany or Japan, but China. More and more evidences indicate that the United States has begun to view China’s rapid military modernization with more vigilant eye. On soft power, the Obama administration has considerably improved American image abroad. Another key variable is America’s strategic choice. My personal view is that the rise and decline of the United States, to a large extent, depends on its own choice, or whether it can stay on the right track. The fact that Obama’s favorability has dropped from 41 to 43 percent shows that American public have doubts about whether their country is on the right track. But among the people I have talked to, including Republicans, most of them think Obama is highly probable to get re-elected. At present Obama’s key tasks are economic recovery, job creation, new energy development, healthcare reform and so on. Regarding international politics, the United States has displayed farsightedness in its behavior and actions. For instance, when new problems arose in the Middle East this time, the United States adopted a cautious attitude, and the country did not directly dispatch US troops Libya in order to avoid repeating the kind of strategic mistakes it made in the Iraq war. With respect to relations with other major powers, the United States has adopted a balanced policy to develop closer relations with all major powers. To make its relations with other major powers closer than relations between these major powers can ensure that the United States will always take the leading position in the international arena. With regards to SinoUS relations, the present Chinese leaders have, on the whole, moved in the right direction. The United States claims it welcomes China’s development and rise; China has also made clear that it hopes the United States will continue to play a positive role in the international arena, and that China itself does not want to and will not seek hegemony. Chinese leaders hold a prudent view on the debate about the rise and decline of the United States. But such a strategy and manner is different and even somewhat contradictory to those held by some Chinese opinion leaders and members of the public. In summary, I do not agree with the declinist view. A vertical comparison indicates that the United States will continue to enjoy stronger military, economic, and technological strength than it used to, maintain the democratic system, rule of law and other core values. Although some doubt is raised with regard to America’s education performance, today



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American universities still attract the best students around the world. This “vote-by-foot” phenomenon indicates that the United States still takes the lead in education. A horizontal comparison, i.e. compared with other countries, indicates that no other single country is in a position to challenge the American leading position as a superpower in the foreseeable future. China and other emerging economies can pose a challenge to the United States, but they are far from having the strength and condition to replace the United States and reshape the world order. The West as a whole may be in the process of declining, but the scope of “the West” is actually expanding. Such countries as Japan, South Korea, and India can be viewed as part of the West because they all basically recognize Western political values. Those who hold different perspectives from the West is yet to rise fully. The United States has now reached a peak of its development. This peak is more like a plateau. In the near future, the United States would experience the ebb and flow of its power in the upper part of the plateau until it reaches the tip. Logic indicates that were the United States to decline, it would only occur because those factors behind its strength would no longer exist. There are many such factors. First, the tradition and spirit of rule of law and its dependence on laws to maintain social stability have served and continue to serve as a pillar of American strength. Second, the consistency and cohesion of its social values have ensured the unity of the nation. Meanwhile the United States has consistently held freedom as the core national ideology. This is an unchallengeable value system that goes beyond all religions and races. Third, the United States, so far, maintained its leadership in technological innovation and institutional innovation, which are also clear evidences of its soft power. Fourth, a developed civil society has enabled the United States to adequately correct its mistakes, and the close relationship between the state and society has also enabled it to make balanced use of state and social forces to deal with diplomatic issues. As long as these factors have not changed, there will not be any substantial change in American position in the world. II. United States’ Global Leadership Zhang Weiying (Guanghua School of Management, Peking University) It is unlikely that US global leadership will be overthrown in the next 10 years, even in the next 20 to 30 years. In fact, US leadership is in line

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with China’s interests. China is not prepared in all aspects to lead the world and it cannot afford the enormous burden of related international responsibilities. In modern history, the United States is the nation with the greatest global leadership. This is because US society is thriving and vibrant, highly capable of self-correction and repair. On the other hand, the United States attracted the best talents in the world, and its melting-pot characteristic laid a solid foundation for US prosperity. Strategically speaking, I once recommended two books for US politicians. The first is The Wealth of Nations by Adam Smith, published in the same year that the American War of Independence (1776) began. The development of the world in the past two centuries was basically continuous expansion of the ideas of The Wealth of Nations. The reason why US politicians should read this book is because their country is now on the way toward protectionism. Not a single country in the world can possibly lead the whole world by being closed. And a closed United States will not have the legitimacy to lead the world. The second book is Tao Te Ching by Lao Tzu. The United States will change its role from leading nations of same or similar values to leading nations of very different values. Under this circumstance, the United States should “stay low like a big country” as mentioned by Lao Tzu in Tao Te Ching and lead the whole world from a low-key approach. But the current leading approach for the United States is to domestically promote freedom and democracy, and internationally seek dictatorship and hegemony. Although no other country can challenge its current leadership, the United States must change its way of leading. In the past two centuries, the world underwent a significant transformation from great divergence to great convergence. Statistics show that during the past two centuries, the correlation coefficient of one country’s population and GDP was one; it began to fall drastically (great divergence) since the 19th century and reached the lowest level in the 1970s before returning to about 0.55 (great convergence) at the beginning of the 21st century. This new trend of great convergence will continue and bring about a sea of change in the leadership of international relations. My opinion is that the global situation and US leadership will to a large extent depend on how China will respond. If China keeps making mistakes, US leadership will cement. My attitude about China’s development changed from optimism to cautious optimism in the past two or three years. This is because something that was originally deemed irreversible has now been reversed. It includes more and more government intervention, the introduction of new price controls, and the return of economic



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planning. In addition, China’s statism has become very influential. Pursuit of self-happiness, a part of human nature, has two basic approaches. One is to make oneself happy by making others unhappy, which I call “the gangster logic of robbery.” The other is to realize one’s happiness by making others happy first, which I call “the market logic.” The development of history tells us that the gangster logic will not work as the disastrous results of World War II launched by Germany and Japan have shown. By producing products loved by people all over the world after WWII, the two countries rose again as a victory of market logic. The United States is a nation that follows market logic, although it occasionally uses gangster logic too. China’s State-owned enterprises are now making use of their monopoly power to expand at the cost of private enterprises. This is very detrimental to China’s development. I am very sure that the more China returns to the planned economy and the dominance of State-owned enterprises, the stronger the US leadership will become. Politically, China’s future development to a large extent hinges on its political institutional reform. A key difference between the development of China and India is that India has first democratized its political institutions before implementing economic liberalization; China has carried out economic liberalization but left its political institutional reform for the future. Specifically speaking, China faces two key challenges: One is populism. The other is nationalism. After decades of development, the legitimacy of the government can no longer rest on the merit of economic development. It is a bold effort to seek legitimacy by promoting political institutional reform. However, it will be very dangerous if the leaders who lack courage or are short of determination and authority to promote political reforms resort to populism and nationalism. Under this circumstance, major reforms cannot be carried out and reversion becomes possible. It is imaginable that when the top leaders are not authoritative enough to make clear their attitude on the wrongdoings of subordinate officials, reversion and defiance may prevail. The combination of nationalism with populism will make it difficult for rational behavior to prevail in China. It is more often nowadays that China does not address problems in line with market logic or the spirit of rule of law. Instead, those problems are first morally judged through public opinion, and there is not any consideration of the legitimacy of the way to deal with these problems. In short, political institutional reform will be a key factor that determines China’s development in the future. Concerning international relations, since China does not have open and firm allies in the world, it is very difficult for China to challenge the global leadership of the United States, with its many open allies. If a nation is

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compared with an enterprise, from the perspective of the theory of evolution, hindrances will emerge after any nation has evolved to a certain point, just like a tree cannot grow all the way up into the sky. I think it is impossible for the United States to decline and fall, but it will begin to tumble downhill compared with other nations and its own history. The US global hegemony may not last too long if China can keep promoting market-oriented reforms, steadily advance political institutional reform, and adopt a proper strategy on diplomacy. But the change in the positions of the United States and China will become very subtle if China chooses the wrong way. In summary, in the next 10 years, the change to China’s political institutions, or lack thereof, will be crucial to China’s development in the future. Under the political framework in the 1980s, the rewards went to those who were capable of doing things or bold enough to promote reforms. But now people are rewarded for not doing things and being patient enough to wait. There is a change in the character of the whole nation. US global leadership will not be challenged in the coming years. It is highly probable that China will overtake the United States as a leading economic power, but that does not mean China can challenge the United States for the privilege to lead the world. The United States surpassed the UK in terms of economic strength in 1890, but its global leadership was established only after World War II. III. Will Beneficial Factors Also Be Reverted into Burdens on US Strength? He Huaihong (the Department of Philosophy, Peking University) I agree with the previous two scholars on most points, but just for the sake of debating, I would like to disagree and raise some questions or different observations. An overview of the United States’ more than 200 years of history shows wars have exerted a huge impact on the United States. If most wars before 1945, especially the two world wars, were believed to have made the United States stronger, wars after them have often affected the United States’ soft power and international reputation, such as the Vietnam War and the second Bush term. Taking into consideration the four factors professor Wang Jisi (王缉思) mentioned that benefit US strength, I am wondering if I can raise this question: Is it the case that beneficial factors have sometimes reversed to cause the United States to make mistakes or even to decline?



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For instance, first, Professor Wang Jisi talked about the considerable consistency and cohesion of values within US society and its ideology with freedom and democracy as the core of that ideology. This is indeed a key factor that makes the United States strong and socially stable. Nevertheless, the export of such values may cause problems if the United States wants to export values such as freedom and democracy, even in a forceful way, out of its strong faith in these values, for example during the Iraqi War. There is always idealism, or sense of mission and even manifest destiny, in US society. A strong faith in such ideals and universalism as well as objection to dictatorship in other countries or regions may lead the United States to forcefully export its values to others without a thorough understanding of the complexity of the world’s cultures and nations. I think there are multiple motivations for the United States to launch several wars in the Middle East, which can never be completely explained by a few reasons such as oil or US national security. They may also include a kind of naïve idealism. So, it is not strange that some people in the United States who firmly defend US interests and are strongly pragmatic have also opposed the Iraq war. Second, the strong cohesion of US social values, the existence of a developed civil society, and the high priority the United States gives to the life security of its citizens may lead to the problem that the United States attached too much importance to its own security. This may cause such differences between domestic and international concerns that it propels the United States to intervene in other nations forcefully without considering the broader security interests of other nations and peoples. Such acts will be deemed by other nations as too hegemonic and offensively unilateral. IV. Antagonism Will Cost our Opportunity to Observe and Learn from the Outside World and Facilitate Our Progress Wang Jisi I am going to elaborate the part of nationalism that Professor Zhang Weiying (张维迎) brought up in his discussion of nationalism and demagogic nationalism. The danger of narrow nationalism lies in basing legitimacy on China’s rising international status, establishing moral standards on the grounds of China’s own interests and wishes and deliberately creating antagonism between China and the West or China and other countries. Such antagonism will cost China the opportunity to observe and

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learn from the outside world and facilitate our progress. Such nationalism will become an obstacle to the progress of China’s reform. China is now in a dilemma: On the one hand nationalism and sometimes even demagogic nationalism are needed to maintain domestic cohesion; on the other hand you cannot be too assertive or tough in the international arena. Now let me answer the question raised by Professor He Huaihong (何怀宏). The United States is not in good shape now. It is unlikely to make major strategic mistakes. On the one hand, the US economy is still in the process of recovering. To seek re-election, President Obama will place a high priority on economic recovery and job creation. On the other hand, the United States indeed attaches too much importance to its security. The United States believes that its security must be based on its military dominance. First, countries such as North Korea and Iran, which are far short of the military capacity to declare war against the United States, want to bargain with the United States only with their military strength. These countries hope to maintain their regimes and at the same time have closer relations with the United States. Hence, besides making nuclear weapons a bargaining chip, they will extend an olive branch to China, hoping China could offer help. But China should understand that the ultimate purpose for North Korea and Iran to seek close ties with China is to improve their relations with the United States. Second, at present only China and Russia have the potential to pose a serious military threat to the United States, but Russia has signed an agreement with the United States on the reduction of nuclear weapons, which is a big step forward to reduce mutual strategic distrust. The United States is increasingly concerned about China’s growing military power, but China is reluctant to enhance military transparency as the United States requested. China still regards itself militarily weak because it has always taken the US military power as its reference point. There are some dilemmas here: On the one hand, China cannot act too tough before the United States and neighboring countries. Nor can it appear too soft in the face of its domestic public. On the other hand, it cannot increase military transparency as the United States requested, but it still continues to strive to reduce the US strategic suspicion through the maintenance of military exchanges. What the United States worries about is that after China’s economic rise, China will hope to seek the same political and military leadership as the United States does. And this is what the United States will never allow to happen.



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V. New Challenges for the United States and China Huang Haizhou (China International Capital Corporation Ltd.) China is among the biggest beneficiaries of globalization. The present global monetary and financial rules are still established under the Bretton Woods system set up after 1945, and China has been benefiting from these rules. Therefore, it is unnecessary for China to break these rules although their improvement is possible and needed. In terms of the international economic framework, the United States became the leader in the international arena through a series of measures after World War II, such as setting up the General Agreement of Tariffs and Trade (GATT), establishing the international financial framework by introducing the Bretton Woods system. Gold began to massively flow out of the United States starting in the 1960s and the dollar was gradually de-pegged from gold before the Bretton Woods system began to collapse in the 1970s, the first low point in US financial history. From the stagnation at the end of the 1970s to the Clinton administration in the 1990s, US finance rebounded to a commanding height, when the East bloc in the international political arena completely collapsed. What people worried about then was not the US fiscal deficit at all, but its fiscal surplus that made it difficult for other countries to purchase US Treasuries and accumulate foreign exchange reserves and for the US Federal Reserve to implement an open market operation. The 2008 financial crisis has given rise to public worries about whether the United States will enter another trough or even a decline. I think if the United States can maintain 3 percent of GDP growth and about 3 percent inflation per year, and a gradual depreciation of the dollar against other major international currencies, it will not be a major problem for the US economy to recover in three years. The next hot spot in the capital market will also probably emerge in the United States. Emerging markets will undergo rounds of boom before a round of crisis. The United States has a boom-bust cycle too. In terms of this financial crisis, I think that 2008 was the lowest point in this circle and that point is now in the past. As to the trend from great divergence to the great convergence Professor Zhang Weiying talked about, I think the world witnessed great divergence during the period between the end of World War II and China’s reform and opening-up, the political changes in the Soviet Union and East Europe, and the fall of the Berlin Wall. While stressing ideological

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s­ truggles, various nations adopted different development paths, resulting in a widening development gap between nations and a worsening environment for international competition that prevented effective allocation of resources around the globe. Since the 1990s the world has been integrated under the leadership of the United States. The United States has come up with a set of rules in line with the laws of the market economy to substantially improve the efficiency of resource allocation, which promotes great convergence worldwide. Some economically less-developed countries with certain natural endowments have been able to catch up with the overall development level of the world economy by opening markets and absorbing foreign investment. Such great convergence brought about not only peace dividends for the whole world but also globalization dividends for opening economies. Globalization will lead to a relative decline in US economic power but it will also further cement US leadership on the world stage. From the 1980s until now, the most important events are, first, China’s reform and opening-up then the collapse of the Berlin wall and the inclusion of East Europe into the West camp. The United States’ great prosperity is inseparable from globalization. The United States’ prosperity has, to a large extent, benefited from the sound development of the world economy that had fluctuated little as a whole. The United States monetary policy makers failed to understand this point thoroughly and made some misjudgments, including running a too loose monetary policy for too long, which indirectly caused the US financial crisis. Greenspan and the Fed at that time had noticed that the US economy was growing rapidly in the absence of inflation and believed this was mainly a result of US technological progress. Because they had not paid due attention to the global economic situation, they had thus adopted a too loose monetary policy for too long that created the conditions for the financial crisis. In fact, overseas markets have become the major source of profits for many big US companies—as much as half of Standard & Poor’s 500 companies’ profits came from overseas markets before the financial crisis. Meanwhile, cheap imports from overseas markets helped lower inflation in the United States. All of these are part of the dividends of globalization that are accumulating from all over the world in the United States. But a fundamental change is now taking place in the global situation. The United States has long enjoyed the goods and services that “outsiders,” such as China and India, provided at the cost of low income and returns. But as the trend of great convergence deepens, more nations and more peoples have been included as “insiders.” They will also expect higher



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incomes and living standards as a larger share of the dividends of globalization. This will definitely lead to a relative decline in US economic power and lift the global level of inflation. On the other hand, because of the scarcity of natural resources, it is unrealistic for China and India to reach the US per capita GDP level with the current technological level. The rise of emerging countries will further intensify energy shortages and fuel inflation. China’s rise in the future will also be considerably limited by constraints on natural resources. The ultimate solution to these problems hinges only on new technological breakthroughs. The world economy is in an era of great transformation to pursue global rebalancing. Conditions for the United States rebalancing include inflation, devaluation of the dollar, economic growth, and technological progress. I believe that the rise of global inflation is unstoppable nowadays, and all the beneficial factors will help the United States recover and grow even stronger. As its economy further recovers and its relative economic power declines, the United States will likely make use of the chance to undergo a round of major adjustments to change its role in the international arena. For instance, it will share more power with other nations in global governance. Energy will be the key to our future development. The United States has been developing conventional and new energy technologies. The big question that the capital market needs to answer now is where the next technological revolution will take place. I think it is very likely that it will be new energy and stem cell-related biological technologies. The first federal law that Obama signed since becoming the US President was to support stem cell research in Silicon Valley. This is unprecedented. If stem cell revolution becomes a reality, it will solve the problem of diminishing demographic dividends in many countries including China. The capital market began a “Long the US, short China” approach in 2011. There are many people in the market who short China, which partly explains why China’s capital markets did not perform well in 2011. This situation may last for a while. In brief, it is both difficult and unnecessary for China to break the present international system. Strategically, China should unite with other nations to enhance mutual trust among nations. Tactically, China needs to engage in a battle of wits. Professor He Huaihong made a joke of the location and theme of the conference, calling this meeting fenghuanghuamei, a pun in Chinese that can mean a beautiful phoenix or a conference on China and the United States in a building called Phoenix Tower. I would add that meizhongbuzu, longfenggongwu means the deficiency of the United States and China

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should be addressed through their cooperation like a harmonious dance between a Chinese dragon and a Chinese phoenix. The United States faces some new problems such as the coexistence of economic recovery and its relative decline in the world economy. China also faces some new challenges including energy shortages, rising inflation and domestic structural problems, economic slowdown, and the relative rise of its economic power in the world. That both the United States and China have their own problems is called meizhongbuzu. The best solution for China is to dance with the United States like a Chinese dragon and a Chinese phoenix. There are many problems in both countries. However, it is precisely because of these problems, some of which demand complementary solutions, that the two countries might work together to find a solution. In this regard, the European Union is a good example. In a sense, the relation between China and the United States is like that between Germany and France. It will be the best result if China and the United States can dance like a Chinese dragon and a Chinese phoenix. Although not fond of the Chinese dragon, the United States has played and will continue to play the role of a dragon. China is fond of the Chinese dragon but needs to play the role of the Chinese phoenix well. VI. Sino-US Gap in Science and Technology Might Still Expand in the Next Decade Yuan Yaxiang (Academy of Mathematics and Systems Science, Chinese Academy of Sciences) I am pessimistic about this topic. China can claim to be the world No. 2 in all aspects such as politics, economy, and culture except for science and technology. Chinese leaders in science and technology created a strong impression of China’s scientific and technological prowess among the public, which might be good for morale; but, in fact, the reality is different. There is still a vast gap between the world’s advanced level and China’s science and technology that may even fall behind that of some developing countries like Brazil and India. There are three pillars for scientific and technological development: people, scientific and technological conditions, and environment for scientific and technological development. And the most important among them is people. The reason why the United States took the lead in science and technology since the end of the World War II is that it attracted a large number of best people in this



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field from around the world. The current situation is that the United States still enjoys absolute dominance in science and technology in the world and the technological gap between it and other nations grows wider. I think the gap between China and the United States in terms of science and technology might expand further in the next 10 years. The human factor is the element that contributes to this gap the most. The reality is that there is a continuous brain drain from China toward the United States, and China is at a disadvantage in the Sino-US competition for talented people. One the one hand, the United States will become even more attractive to the best talents because of its leading position in science and technology. On the other hand, many policies adopted by the Chinese government are actually facilitating the brain drain of our brightest or potentially brightest people. For example, I remember that the Chinese government adopted a talent-policy years ago described as importing top talents, stabilizing outstanding talents, making good use of current talents and fostering future talents.2 That fostering future talents is a cliché upon which I do not need to comment. However, the other three parts have in essence divided talents into “our people” and “yet-to-be our people,” trying hard to woo the latter while paying little attention to the former. Ridiculously, the status of the same person can be changed from a “top talent” to an “outstanding talent” a few years later then to a “current talent” another few years after that. Such a policy has only encouraged the outflow of talented people who will stay overseas and not return until having been gone long enough. It is just like the joke that people tell: “It will be better to join the revolution later than sooner; not joining it will be even better.” The second component is the state of and environment for scientific research. There are mainly four factors behind the development of science and technology. The first is the military that boosts scientific and technological progress. The United States’ scientific and technological development in the post-World War II era was, to a large extent, driven by the stimulus from and its need to carry out an arms race against the Soviet Union, involving aerospace technology, the Internet, and new materials. The second is social and economic development, including big companies’ technological demands. The third is development of public welfare 2 Ministry of Science and Technology, “China’s Basic Studies Targets for 2010,” in China Science and Technology Newsletter, No. 219 (April 10, 2000), http://www.most.gov.cn/eng/ newsletters/2000/200411/t20041129_17606.htm.

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undertakings, such as resource and environmental protection, healthcare provisions, and disease prevention. The fourth is scientists’ curiosity, for example free exploration purely to understand the cosmos and nature. China lags far behind the United States on all four aspects, something upon which I do not want to elaborate. Unfortunately, these gaps are still growing wider. (How I hope I am wrong!) For instance, China’s large enterprises would rather spend a lot on purchasing software from overseas markets than commission domestic scientists to develop it. Besides, China still lacks the spirit of science. In the past several decades, the problem of science and democracy that the May Fourth movement raised had actually not been solved. The essence of science is innovation, or to be different. But now China’s evaluation system, policies, and education all discourage innovation. So China is still used to copying others’ creations and would rather like to make improvements on others’ creation than be bold and courageous enough to create new things. Worse, the science and technology circle in China is eager for quick success and particularly fond of huge projects. The approach adopted to manage engineering projects may be useful for the development of technology but will never work for the progress of science. China’s country’s science and technology circle is still deeply influenced by feudal thoughts, feudal ideas, and feudal behaviors. It is still a common practice to “become an official after becoming a good scholar.”3 When evaluating scientists and technology researchers, Chinese society, including the science and technology circle, attached too much importance to its ranks, positions, and honorary titles instead of academic achievements and thoughts. This problem will seriously hinder the sound development of science and technology, and it will affect the healthy growth of young scientists and technology researchers. In addition, the increasing deterioration of the academic atmosphere will severely affect China’s efforts to foster scientists and technology researchers. If these problems cannot be addressed promptly, China’s science and technology circle can hardly foster top talents and make major breakthroughs in the next 10 years. In short, I think the gap between China and the United States in science and technology is widening and this trend will not reverse any time

3 The Sayings of Confucius, translated by Leonard A. Lyall (London: Longmans, Green and Co., 1909), 98. [Translator’s Note: This quote differs from the original translation by Lyall because this chapter’s translator provided it by looking at the original Confucian text: 学而优则仕.]



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soon. This will eventually obstruct China’s economic development, limit the growth of its military competitiveness and undermine China’s international status. However, as a blessing in disguise, the vast gap between China and the United States has, so far, persuaded the US science and technology circle not to treat China as a competitor. So, unlike in many other fields, such as the economy and trade, the US science and technology circle has not tried to control and limit China’s development in this regard, providing a favorable environment and opportunities for China to make full use of international resources to catch up quietly through international exchanges and independent innovation. The competition between China and the United States will be permanent. But I think that China should now avoid mentioning China as equal to the United States, embracing the talk of G2, or presenting our country as the world No. 2. China should do its best to include Russia and the European Union to improve relations with these countries and to keep a low-key posture. Nowadays, the international community is no longer a two-player game but a multi-player one under which a cooperative solution exists. To include more major powers into this game may help develop multi-polar international cooperation to counterbalance unstable factors in Sino-US relations. Finally, I would like to talk about institutional innovation. China definitely needs to embrace it but the question is how. I believe that social reforms require theoretical guidance, which means scholars and political elites must think ahead of time, and social reforms cannot be implemented like crossing a river by feeling for stones or blindingly following the approach of trial and error. Efforts to maintain stability might have worked for hundreds of years, but they are surely not the most optimal approach. History has proved that no development and no progress will only lead to the road of decline—and the only way to realize long-term peace and stability for a nation is to keep making progress. He Huaihong I think the US domestic policies and institutions should not be scorned because of some of its hegemony acts in the international arena. On institutional innovation, for instance in the field of science and technology, China’s development and prosperity may hinge on its ability to learn from and make use of much of the United States’ experience in developing science and technology. Original scientific and technological

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innovation definitely requires absolute freethinking and exchanges of minds as well as the support of funds that can flow freely. Such freedom includes being able to repeat trial and error again and again and respond rapidly and timely to seize and make use of all kinds of chances. Hence, first-class scientific and technology achievements benefit most from free and natural competition but not from man-made national plans and “money piling,” not even to mention “the distribution of spoils” of some domestic research funds. Zhang Weiying It is actually anti-science to manage science and education undertakings with the mindset of engineering management. It is a key obstacle to social progress to treat society as an engineering project. How to run universities is indeed a very important, current issue for China. The age at which Chinese students start to study abroad has become increasingly younger, revealing a kind of dissatisfaction about China’s education system. I believe that history develops neither by leaps nor along a strait line. It was after World War II that US science and technology, and universities began to rise and have since maintained their dominance. The United States’ institutions are very attractive to talented people. From an optimistic point of view, first, both foreign universities and foreign companies are fostering talented people for China. If Chinese institutions can be improved, talented people will be attracted back to China to become pillars of Chinese society. Second, a key difference between the world today and the world two centuries ago is that technological progress was made at a snail-like pace and spread very slowly 200 years ago, but technology progresses fast and spreads even faster now. China’s social and economic progress in the past is not a result of China’s technological progress but that of the whole world, especially advanced countries led by the United States. It will be the case, too, in the future and China can make use of others’ technology instead of depending only on China itself. Besides, technology was protected as a secret in the past; there is now a market for technology in that patents and research can be obtained by being bought overseas. If the technology market can be made good use of, the constraints that China’s science and technology imposes on other aspects may not be unchangeable.



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Huang Haizhou Let me add some points. First, it is difficult to be No. 2. Since the United States became the world No. 1, there have been three No. 2 countries: the Soviet Union, Japan, and Germany. That they all do not fare well now shows how difficult it is to be the No. 2 in the world. Second, efforts to maintain stability are difficult to sustain. If the Ming and Qing dynasties were deemed capable of maintaining stability for 300 years, it was because China was a closed country then. Now, after the external environment has fundamentally changed, can stability be maintained for 300 years? Third, China faces a difficult battle in making progress in sciences and technologies. I would like to take the competition between the United States and Japan on computer development as an example. Japan’s science and technology system is very similar to China’s. In the 1960s, after realizing the importance of computers, Japan made a development plan to concentrate all its support on five organizations, including universities and companies, to develop them, which basically meant to find the smartest people and provide them with unlimited funds. In the US computers developed through the thousands of experiments conducted, including many in garages. The mechanism that the United States adopted in promoting scientific and technological progress is based on the law of large numbers, instead of picking up the few smartest to implement the task. Everyone can have a try and many people tried their ideas before the best ones were selected by the market and succeeded. The compensation of this mechanism is that once one of them succeeds, the reward for this one person alone will be enough to cover all the costs of the other people. It also has the capital market as an incentive to amplify the compensation. In the early period, when a country was trying to catch up to the world level, it could depend on imitation; but when it progressed close to the world leading position, it has to innovate by itself. China’s economic development in recent years actually benefited much from imitation and efforts to catch up with the world level. But now China is in the frontier and has to innovate by itself, which means the country must adopt a new system to encourage innovation and enable all kinds of people to make full use of their talents. In this regard, China is not totally hopeless. China can learn from US universities on how to enhance relations with businesses and develop a mechanism to identify and foster talented people in order to select the best ideas.

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Yuan Yaxiang During the period catching up with others, imitation might work in the early period when the technological gap remains substantial. It is because China is falling so far behind, that others will transfer technologies for it to learn and imitate. But when China has narrowed the technological gap to a certain extent, others will be cautious and keep secret their key technologies. Imitating what others are doing or have done will only enable China to reach the level that others achieved in the past. More importantly, while China is still imitating, what others are doing might become totally different and even the conception might be changed completely. If one can only imitate what others have done, one will always fall behind and the gap can only grow wider. China must fully understand the importance of this problem. Zhang Weiying Another problem is that the United States’ prosperity and its favorable demographic structure is closely related to its immigration policy. Demographic structure is of vital importance because the purchasing power in the market and the supply of labor all require a large number of young people. If China’s labor force and population mobility cannot meet the demand, they will cause a series of big problems. China’s population problem is crucial to its future development. In terms of economics, the forcefully enforced one-child policy was a big mistake that treated the population as merely a burden. The large size of the population was then made as an excuse for the country’s lack of development. It will make an even larger mistake if this policy cannot be adjusted in a timely fashion. The mistake in population policy is horrible because its dire consequences will loom many years later. But nobody dares to adjust family planning: It is still a basic national policy. I believe that the decline of Japan is closely related to its aging population. I think there are two constraints on China’s development: One is the political system; the other is population.



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VII. China’s Progress in Political Order Hinges on Enhanced Rule of Law in the Next Decade He Huaihong I would like to talk about China from the perspective of political order and try to predict its future, so I will begin by discussing the past. In his new book, The Origins of Political Order, Francis Fukuyama pointed out three factors behind a good political order: a strong state, the rule of law, and mechanisms to hold the ruler accountable. I think it would be acceptable to make use of some of his analysis. Let me start with a brief review of history. From the West Zhou dynasty to the Spring and Autumn period, Chinese society was feudal and hereditary. In Fukuyama’s view, the Qin dynasty had set up the first real state in the world, a strong state. But I think the Qin dynasty only finished half of the task of the empire because it had neither solved the problem of long-term peace and stability nor managed to address the reproduction of the ruling class. It was during the Han dynasty that a truly stable traditional state system with lasting peace and stability was first established, which not only made Confucianism the only political guidance but it also set up a selection system to address the continuous supply of officials to replace the hereditary system. The choice between a hereditary system and a non-hereditary system might be a key factor determining whether a major state or an empire can enjoy stability and prosperity, and it distinguishes a modern country from an ancient one. Until now, we can still see the competition between hereditary and non-hereditary factors in different countries including China. There are notable implications and shortcomings in China’s ancient selection system for modern nations. First, there are strict rules for the selection procedure. The origin and selection of officials, an important aspect of the state, is strictly ruled by laws, although the political society is not as a whole ruled by laws. Second, the anti-hereditary selection result delivers high-degree equity on political opportunities to become officials, which differs from political participation and social equity. Third, it helps the establishment of a responsible and highly cultivated ruling class that is certainly not an accountable government under democracy. The traditional Chinese Empire had already fallen at the beginning of the 19th century. I will not talk about the “complete denial” of tradition in the past century, but focus on the present. After recent years of rapid

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e­ conomic growth, China today might have become the strongest state it has ever been in history; however, it still has some problems compared with the United States. An US friend of mine once said: “The US faces many problems, even serious problems, but none is fundamental.” The remark is thought provoking. It is undeniable that China has achievement great progress compared with its own past and other third world countries. Are there still fundamental problems? For instance, are ideology and political institutions divorced from social economic reality and people’s everyday lives? Are intellectuals who should think and provide ideas split among themselves? Therefore, I think China has now come to a point where the road separates and we have to make a choice. I am not talking about a crossroads where China has only two choices: forward or backward, left or right. Instead, China has multiple complex choices or choice sets. While facing many choices, China has to make a decision because it’s required to do it while taking into account both domestic and international situations, particularly in view of the following factors and cases: (1) China can no longer hide its capacities and bide its time after the Beijing Olympic Games and the global financial crisis; (2) income disparity and distribution problems emerged after the rise of the Chinese economy that generated a large amount of wealth; (3) while decentralization of power alone seemed to be enough in the past, the country now needs more active and innovative policies; (4) to enhance the country’s cohesion at home and attraction to outsiders, it needs to increase its soft power to attract and inspire people. In short, we might have been able to cross the river by feeling for stones before reaching deep water, which means to learn as much as possible from global experience and that of developed countries. But in future we will need farsightedness to rely more on independent innovation. Although it is difficult to make a prediction, I still want to try to have a look into the future, or to express my hope. In my view, the progress of China’s political order in the next decade hinges on the development of rule of law or, in other words, the establishing, strengthening, implementing, and enhancing of the rule of law. The process involves the relation between rule of law and democracy. Like many friends I think the order should be that rule of law come first and then democracy. The progress of the rule of law can even be drastic while democracy is realized gradually. Rule of law is training for democracy, development of citizenship and a guarantee for public welfare, civil rights and democracy. For China, it is not easy to go wrong when strengthening the rule of law before causing serious social unrest. The sort of rule of law must be one that guarantees



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people’s basic rights and is in line with the constitution. It should include not only a complete legal system but should also establish the rule of law and develop a general respect for laws. During many battles between power and law, if the law defeats the power in every or most cases, it will then be possible to develop and perfect a rule-of-law society and a civil society. Although the ultimate goal is democracy based on rule of law, it is realized via rule of law. Social justice should also be the kind of justice that is realized via laws and reflected as legal achievements. Although the current situation for the rule of law is not optimistic and it is still frequently undermined by power in many cases, I believe that China has reasons to be hopeful about, or at least struggle with a spirit of optimism, for China’s progress toward the rule of law. The concept of rule of law is not as sensitive as some other concepts. China can learn and draw lessons from the experience of democracy and rule of law in overseas Chinese societies, for instance “the rule of law that contains freedom” in Hong Kong, “democracy that contains tradition” in Taiwan, and even “lifestyles that contain faith” in ethnic regions such as Tibet and Xinjiang, which can be used for reference to improve the spiritual life of the Chinese nation. Not only China’s own history but also modern experiences from areas of the same ethnicity or culture as China’s tell us that rule of law is not unsuitable for the Chinese nation and the same can be said for democracy. So the national condition or the condition of the people cannot be used as an excuse to postpone the rule of law or democracy. In summary, I hope that China will make a significant step forward toward establishing and strengthening the rule of law in the next decade, developing public respect for laws from top to bottom, making good use of and building up the state’s capabilities through the rule of law, and ensuring an accountable government, so as to find a way for realizing China’s longterm peace and stability. Wang Jisi I don’t think it realistic to implement the rule of law in China nowadays. The more practical choice is to allow the growth of civil society. The United States is very vigilant against the investment of some large Chinese state-owned enterprises, arguing that these enterprises are there to steal US technology and grab US resources. Some Americans even believe that investments are aimed at controlling the United States in the long run because these enterprises are directly linked with the Chinese Communist Party and the Chinese government. My personal view is that if China can

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show its domestic diversity to the United States, the latter will be able to rest assured. But the present problem is that the United States does not believe the diversity it has seen in China, doubts about China’s credibility, and believes that domestic businesses in China are just playing a duet. So, it is very important for China to at least tolerate some different opinions and establish a civil society. In the United States’ view, at present China is strengthening centralization and doing it quite well. This is why the United States cannot rest assured. I am not saying that we must let the United States feel relieved. What counts most is that it is in China’s own interests to diversify its economic forms and enhance more inclusive politics. In this sense, I think China is very much like the United States, sharing the view that the real world is that of power politics. However, I am not a pessimist. In this regard, China can learn from Europe. Europe has developed into the European Union and established a stable order based on rule of law not on power politics dominated by one or several powers. The world today also needs to seek such an order which is based on rule and can be spread around the globe. But with regard to the present international order, China and the United States hold different views. China believes that the United States is too hegemonic while the United States and other countries regard it dreadful to allow China to rule the world. China is now still trapped in the concept of “multi-polarization”, trying to figure out which one or which several countries can dominate the world affairs but failing to set about formulating a more legitimate order based on rule of law. Zhang Weiying I believe in the next 30 years China should focus on building up a judicial and civil society in the first 15 years, and promote democratic reforms in the latter 15 years. It is important to put judicial reforms before democratic reforms. In the long run, China needs to explore a new path. Such exploration may draw some lessons from the experiences of Hong Kong, Taiwan, and even Vietnam. China can begin the exploration with election based on functional organizations, and intra-Party democracy and may gradually realize the transition toward democracy in 30 years. Huang Haizhou It is very important for China to promote the rule of law—but how? I believe that, under current circumstances, the process should be divided



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into two parts based on the constitution and the company law respectively. The constitution and company law are quite different: The former is one-person-one-vote to emphasize equality among people; the latter is one-share-one-vote to protect the rights of shareholders and investors. It takes the one-share-one-vote company law to ensure efficiency, and the one-person-one-vote constitution to guarantee the spirit of freedom and democracy. The United States’ economic system is one-dollar-one-vote, similar to one-share-one-vote; but US citizens elect the US president under a oneperson-one-vote system. This subtle combination ensures both efficiency and equity. China also needs to find a mechanism to balance the two aspects to ensure protection of the interest of capital as well as civil rights. The European experience, especially cooperation between Germany and France that made a great contribution to the establishment of the European Union, may provide some guidance for the Sino-US relationship and its possible contribution on the international stage. It will be best if China and the United States can “dance like a Chinese dragon and a Chinese phoenix.” The United States doesn’t like the Chinese dragon but may need to keep playing the role. China, as the No. 2, needs to play the role of the Chinese phoenix well in the “dance between a Chinese dragon and a Chinese phoenix.” VIII. Respective Interests and Values of China and the United States Zhang Weiying US politicians are too politicized on economic issues and Chinese are too emotional, making many problems difficult to address. For instance, what the actual benefit is for the United States is still unclear on the issue of the revaluation of the yuan. But at least two effects on the United States will be predictable: (1) US consumers will pay higher prices, and the United States will face more rapid price hikes; (2) it will exert a huge effect on the profit structure of big international businesses, especially transnational companies and brand companies that dominate markets generating fat profits for them. The revaluation of the yuan will erase some of the profit these transnational companies make and thereby affect their overall structure.

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Conflicts in the relations between China and the United States mainly exist in two regards. One is the conflict of interests—the two countries compete hard on geopolitics and resources. The other is the conflict of values. The Sino-US relationship is always centered on these two conflicts. For instance, the Taiwan question is a problem of interests. Internationally, the United States often scrambles for its interests under the banner of values. However, the United States is sometimes confronted with the conflict of its pursuit of interests and pursuit of values. For example, some people supported by the United States in the Middle East are—or were—dictators, such as Mubarak, a fact against US civilian values. And once these countries are in trouble, the conflict between US interests and US values will be laid bare. According to my observations, during recent problems in the Middle East, the United States at last chose to deal with them over a concern for values instead of blatantly supporting the dictators. The United States’ internal conflict will cause trouble for the international community and affect Sino-US relations. Wang Jisi On the whole, the United States does not face an irreconcilable contradiction between its interests and values. In the US view, the fundamental reason why the Middle East is in big trouble with the United States lies in their difference in values. The values of Muslim countries are theocracies and dictatorships but not democracies. If the Middle Eastern countries can be turned into democracies, then there will no war. It is a very naïve but deeply rooted idea, i.e. democracies are good countries and do not make war on each other. But the reality is different and the US elite know it. If the theory of democratic peace is to be valid, that only means mature democracies do not make war on each other. The countries which are undergoing transition from dictatorship toward democracy are at the most dangerous period. In this turbulent era, some people will stand up against the United States, against democracy. The general public will be mobilized. Nationalism, even demagogic nationalism, and anti-US sentiments will be brought to its full play. The problem is that in these countries, the rise of any leader depends on upholding the banner of nationalism, which in this context means turning against the United States and opposing American version of democracy. Although there are indeed some contradictions between US interests and values, they will not exist in the long run. Top



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US leaders all understand that it takes time for democracy to prevail and it is impossible to advance democracy by leaps and bounds. The United States has taken freedom and democracy as its core values. For the United States as a whole, its core ideals and fundamental values are consistent. However, its actual policies are not. I don’t think that there are fundamental contradictions between China and the United States. Their disagreements on such issues as energy, trade and others can and will be solved. What matters now is to resolve their political differences, or the question whether China wants absolute benefit or relative benefit. The United States thinks that China’s long-term goal is to overtake the United States and become the world No. 1 and the only reason why China does not seek hegemony now is that China has not yet obtained the capability to achieve it. China believes that in order to maintain its global hegemony, the United States does not want to see China’s rise. It is true that the United States is suspicious of the rise of a country which has a different political system from that of the US. In the past, the United States thought that China was actually pursuing capitalism under the symbolic banner of socialism and its recognition of the United States would only make it more like the United States. But new signs in China nowadays, such as the trend of the expansion of State enterprises at the expense of the private sector and the launch of the “broad political campaign” et al. have all given rise to US suspicion that China would become the largest authoritarian state. This is what the United States is on guard against. The United States believes that if a country becomes a free country and a modern society, it must look more or less like the United States itself. It will be unacceptable to US values if a dictatorial and authoritarian country becomes the world’s largest economy. Yuan Yaxiang I still feel anxious. If a practice in the past did not cause serious problems or did not bring about undesired consequences, it is very likely that it will be implemented continuously. Therefore, some obviously unreasonable practices are extended. Consequently there will be problems. I think it is correct today to maintain stability, but it is necessary to study political institutional reform with foresight on the premise of maintaining stability. China cannot keep sticking to the old practice, and be complacent and conservative only because that practice has seemed to work. For instance,

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democratic elections can be first introduced step by step within the Party. From a philosophical point of view, moving forward continuously is the best guarantee of stability. Wang Jisi The United States argues that China’s reform has almost halted and lost direction. If the current trend of the expansion of the State sector at the expense of the private sector and the increase of the efforts to maintain stability is regarded as China’s direction, then such a trend indicates that the country is less confident nowadays than more than a decade ago. For those pioneers of China’s reform in the early 1980s, American economic system was viewed as an ideal model to promote China’s modernization. Or at least China should learn first from the four Asian Tigers and then from Japan. As China reform’s continued to deepen, the model of four Asian Tigers failed, and Japan declined after China decided to learn from it. Against this background some people in China begin to develop their own development model and they feel that they are on the way to success. Therefore, so far, so good. There is no need to carry our further reforms. Zhang Weiying The Chinese culture is very inclusive in that many foreign cultures have been absorbed into it during its history. As to struggle, I think there will be struggle so long as there is power. But it is only in the past century that the culture changed into a complete struggle, one that involved so many ordinary people. Wang Jisi So the thesis of “peaceful development” is actually not a cultural issue but a political one. As to China’s core values, the only explicit one is statism, or the relationship between State and society. China is viewed as an omnipotent state capable of concentrating resources to achieve great success. This is what distinguishes China from other countries. I believe that no other country can duplicate the so-called Beijing Consensus or China model unless they can implement a top-down system with party organizations at each level as the CPC does. Such an institutional system is an accurate reflection of China’s core value.



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Zhang Weiying There had been civil society in Chinese history before 1949, but now the force of the government penetrates every place. Wang Jisi Just as mentioned above, this institutional system is the embodiment of China’s mainstream value. The Chinese people will use such a value to observe the world. This value is also viewed as an important source of Chinese soft power on the international stage. China has set up a set of rules to which everyone is supposed to stick so long as they are Chinese citizens. Everyone’s position in society is clear-cut. Such a set of rules have evolved into a relative stable system and there is little room for dramatic change. Zhang Weiying I believe it is ideas and thought that have influenced history. So my attitude is both pessimistic and optimistic. It is sad that the spread of thought is still very slow. Fortunately, thoughts are still changing unconsciously. Opinions among young people are quite different today. The situation in China is that, on the one hand public opinion has been tightly and timely controlled; on the other hand, information is spreading more rapidly as new things are continuously coming into being. The ideology that China upholds now is divorced from the Chinese reality. Under such circumstances, it is very difficult to have core values because people cannot honestly and truthfully express their opinions. The current problem for China is that it has made economic transformation a problem of macroeconomic issues, monetary policies, and fiscal stimulus. But economic transformation can be realized only through market development and entrepreneurship. On the development of the domestic market, China’s best achievement in recent years is the substantially reduced cost of transportation, but its biggest problem is prohibitive transaction costs. China’s institutional system has made the market transaction cost very expensive to prevent entrepreneurship from being brought into full play and thus hinder economic transformation. The socialist planning economy will only exert limited effect on mature industries by lowering efficiency a little bit. But genuine entrepreneurs

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need to keep in control and judge what will happen in the future. The intervention of power will only hamper the role of entrepreneurship. The concept of democracy cannot be applied in the economy but only in politics. What matters most for the economy is freedom, independence, and the right for everyone to make choices and judgments for themselves. Economic freedom is more important than political democracy. Currently, State-owned enterprises are expanding restlessly through their monopoly of resources. The realization of economic liberalization depends, to a large extent, on whether the Chinese people accept the basic concept of property or that it is legitimate for a person to earn income by working hard. Wang Jisi The order of China’s core values is indeed somewhat different from that of the United States. The core values of the average Americans can be found in the code of conduct of former US President Lyndon B. Johnson. He said: “I am a free man, an American, a public servant, and a member of my party, in this order and always.” Being a free man is of primary importance here. No matter how it is practiced in reality, the pursuit of freedom is of a high priority in American core values. But in China, the order of the core values starts with being a Party member, then a public servant, and then a Chinese. Being “a free man” seems not to be a proper goal. This is the fundamental difference between the Chinese values and those of the United States. Zhang Weiying The State itself cannot exercise rights. It is individuals who are exercising rights. The State economy is a position-based right while the private economy is a property-based right. Core values must relate to rights. The mainstream values should form on the basis of free choice. Without free choice, it is impossible to form real core values. He Huaihong I would rather not talk about consensus on values and core values but discuss consensus on norms and universal ethics. A basic difference between modern ethics and traditional ethics is the distinction between values and norms or between “good” and “just.” Values are things that people



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in general think “good” and we pursue and prioritize; norms are about the behavior and measures that we use to pursue them. In a diversified modern society, the values of everyone cannot be unified and neither can the values and ideas of every national state. However, I still hope to reach a core consensus on behavior norms such as forbidding the killing of innocent people and ignoring the basic rights of others or other countries. But the moral requirement between countries is in fact lower than that between people within a country, and we may only be able to require a “life” principle and a “consideration” principle. For instance, war and forceful conflict should be avoided with maximum effort and every country should take into consideration the basic rights of other countries when pursuing its major interests. Of course, such a norm requires the backing of power to propel any big and strong country to comply.

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appendix

CONTRIBUTOR LIST Wang Jisi (王缉思) is Dean of the School of International Studies and Director of the Center for International and Strategic Studies at Peking University. He is Honorary President of the Institute of American Studies under the Chinese Academy of Social Sciences, and has been member of the Foreign Policy Advisory Committee of the Foreign Ministry of China since October 2008. He is currently a Global Scholar at Princeton University (2011–2014). He advises a few U.S. foreign policy think tanks. He is the chief editor of International Political Research and serves on the international editorial board of The American Interest and Global Asia. His main research interests include U.S. foreign policy, Sino-US relations, and international politics. Selected Publications of Wang Jisi: “China’s Changing Role in Asia.” In Chinese Images of the United States, edited by Carola McGiffert. Washington. D.C.: Center for Strategic and International Studies, 2005. “China’s Muscular Nationalism.” New Perspectives Quarterly, 13 (1996). “Chinas Search for a Grand Strategy: A Rising Great Power Finds Its Way.” Foreign Affairs 3/4 (2011). “Chinas Search for Stability with America.” Foreign affairs, 9/10 (2005). “From Paper Tiger to Real Leviathan: China’s Image of the United States Since 1949.” In Chinese Images of the United States, edited by Carola McGiffert. Washington, D.C.: Center for Strategic and International Studies, 2005. “International Relations Theory and the Study of Chinese Foreign Policy.” Chinese Social Sciences Quarterly, Volume 1, 2 (1993). “The Logic of American Hegemony.” American Studies Quarterly, 3 (2003). “Multipolarity versus Hegemonism: Chinese Views of International Politics.” In Project on Conflict or Convergence: Global Perspectives on War, Peace and International Order, edited by Samuel Huntington. Cambridge, MA: Harvard Academy for International and Area Studies, 1997. Guo Shuqing (郭树清) is Chairman of the China Securities Regulatory Commission and Executive Committee Vice Chairman of the International Organization of Securities Commissions (IOSCO). He has been acting governor of Shandong Province, China since March 2013. He served as Chairman of China Construction Bank (March 2005–September 2011), Deputy Governor of the People’s Bank of China (March 2001–February 2005), and Vice Governor of Guizhou province ( July 1998–February 2001). His main areas of research include macroeconomics and comparative economic systems. He is known as an open-minded, insightful scholar and official. He is a main participant in China’s economic reform. Selected Publications of Guo Shuqing: “Potentials and Problems of the Chinese Economy.” International Economic Review, 6 (2010). “Some Thoughts on Basic Problems in China’s Economy.” International Economic Review, 3 (2007). “The Internal and External Imbalances of China’s Economy.” Economic Research Journal, 12 (2007). The Face of the Two States of Imbalance. Beijing: Renmin University Press, 2007. Of the Overall Gradual. Beijing: Economic Science Press, 1998. The Economic System Transition and Macro-Control. Tianjin: The Tianjin People’s Publishing House, 1992. The Comparison of the Price System. Zhejiang: Zhejiang People’s Publishing House, 1987.

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Li Daokui (李稻葵), Ph.D. (1992) in Economics, Harvard University, is Professor of Finance in the School of Economics and Management at Tsinghua University. He is also the director of the Center for China in the World Economy (CCWE) at Tsinghua University and the vice president of the China Society of World Economy. He is active in public services, currently serving as a member of the Monetary Policy Committee of the People’s Bank of China, a delegate to Beijing People’s Congress and a member of the Chinese People’s Political Consultative Committee. He is now a member of the Global Agenda Councils and a Rapporteur of the International Financial Institutions Reform Cluster of the Global Redesign Initiative (GRI) of the World Economic Forum based in Davos, Switzerland. He is researcher at the European Centre for Economic Policy (CEPR) and researcher of William Davidson Institute of the University of Michigan. He serves on the editorial board of the academic journal Economics Bulletin. His main areas of research include China’s microeconomics, economic development model and comparative study on the institutional changes, as well as country development strategies. His on-going research projects include the survey of economics research sponsored by the Ministry of Education and the internationalization of RMB supported by the National Science Foundation of China. He is also leading a research team working on reevaluating the GDP and economic structure of ancient China, including the Ming Dynasty. Selected Publications of Li Daokui: Bai, Chong-En; David D. Li,; Qian, Yingyi; Wang, Yijiang. “Financial repression and optimal taxation.” Economics Letters, February, Vol. 70, Issue 2 (2001). Bai, Chong-En; David D. Li; Tao, Zhigang; Wang, Yijiang. “A Multitask Theory of State Enterprise Reform.” Journal of Comparative Economics, (December 2000) Vol. 28, Issue 4. “The Coming Crisis: A Global Perspective.” International Economic Review 6 (2011). Cornelli, Francesca and David D. Li. “Risk Arbitrage in Takeovers.” Review of Financial Studies, Vol. 15, Issue 3 (2002). “Institutional Entrepreneurs.” American Economic Review, Vol. 96, No. 5 (2006). “Political Conditions for Reform: China VS. Eastern Europe Revisited.” Journal of European Economic Association, Vol. 4, No. 5 (2006). “The Soft Budget Constraint of Banks.” Journal of Comparative Economics, Vol. 35, No. 1 (2007). “The U Curve of Labor Share in GDP during Economic Development.” Economic Research Journal, 1 (2009). Zhang Yunling (张蕴岭) is Professor of International Economics and Academician of the Chinese Academy of Social Sciences (CASS). He is Director of the International Studies Division and of the Institute of Asia-Pacific Studies at CASS. Professor Zhang Yunling is Executive Vice-President of Chinese Association of Asia-Pacific Studies. He is a member of the National Committee of Chinese Political Consultant Conference. His expertise and research interests include regional relations in Asia-Pacific, world economy, international relations and economic development policy. Selected Publications of Zhang Yunling: China and Asian Regionalism. Hackensack, NJ: World Scientific Publishing Co. Pte. Ltd., 2009. “China’s Economic Integration with East Asia.” Contemporary Asia-Pacific Studies, 1 (2006). “China’s Regional Strategy, the World Economy and Politics.” World Economics and Politics, 6 (2004). “Innovation and the East Asian Cooperation: the International Economic Review.” International Economic Review, 1 (2010). Rising China and World Order. Hackensack, NJ: World Scientific Publishing Co. Pte. Ltd., 2010. The World Market and the International Environment of China’s Foreign Trade. Beijing: China Social Sciences Publishing House, 2007.



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Su Changhe (苏长和), Ph.D. (1999) in Law, Fudan University, is Professor and Deputy Dean of the School of International Relations and Public Affairs at Fudan University. He is also the Executive Director of the National University Institute of International Politics; the Executive Director of China-United States Society; and the Director of the United Nations Association of China. He worked in the Department of International Politics at Fudan from July 1999 to June 2006, and the School of International and Diplomatic Affairs at Shanghai International Studies University (SISU) from July 2006 to June 2011. Dr. Su was a visiting scholar at the University of Illinois at Urbana-Champaign (UIUC) and the University of Lund, Sweden. His main research interests include world political theory, China’s politics and foreign policy, and international organizations. Selected Publications of Su Changhe: Bolt, Paul; Su Changhe, Sharyl Cross, eds. The United States, Russia, and China: Confronting Global Terrorism and Security Challenge in the 21st Century. Westport, CT: Greenwood Publishing Group, 2008. “China and the International System: In Search of Inclusive Partnership.” Foreign Affairs Review, 1 (2011). The Global Public Problems and International Cooperation: a System of Analysis. Shanghai: Shanghai People’s Publishing House, 2000. “New Overseas Chinese Interest Management Perspective.” Exploration and Debate and Free Views, 8 (2011). “The Process, Behavior, Structure, and Knowledge of the Emerging Chinese Model of Global Governance.” International Politics Quarterly, 1 (2011). “The Role of the U.S. in Cross-Strait Negotiations: A Mainland Chinese Perspective.” In Conflict Management, Security and Intervention in East Asia, edited by Jacob Bercovitch, et. al. London and New York: Routledge, 2008. “Understanding Chinese Diplomatic Transformation.” The Hague Journal of Diplomacy, No. 4, 2010. Li Xiangyang (李向阳), Ph.D. (1998) in Economics, Chinese Academy of Social Sciences (CASS), is Researcher and Director of the National Institute of International Strategy at CASS and the Vice-President of China Society of World Economy. He worked at the Institute of World Economics and Politics at CASS from 1988–2009. Dr. Li’s main research interests include international economics and firm theory. Selected Publications of Li Xiangyang: “The Financial Crisis’s Implications on International Trade and Finance Order.” Economic Research Journal, 11 (2009). The Market Failure and Government Intervention: a Study on New Keynesian Economics. Beijing: China Financial Publishing House, 1994. Of the Corporate Reputation, Corporate Behaviour and Market Mechanisms. Beijing: Economic Science Press, 1999. “Prospects of the International Financial Crisis and World Economy.” Finance and Trade Economies, 1 (2009). “Prospects of the World’s Economic Center of Gravity Moving Eastward.” International Economic Review, 1 (2011). Song Hong (宋泓), Ph.D. (2001) in Economics, Institute of International Economics at Nankai University, is Senior Fellow of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences. He is also a Professor in the Graduate School of CASS and the Director of the International Trade Research Office at CASS. Dr. Song Hong is one of the most authoritative experts in the field of international trade in China. His main research interests are foreign direct investment, transnational corporations and international trade, with a special interest in the impacts of multinational enterprises on industrial development in developing countries, especially in China.

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Selected Publications of Song Hong: “Best trade theory.” The Journal of World Economy, 6 (2008). “Chinese Private Direct Investment and Overseas Chinese Network in Africa.” China &World Economy, Vol. 19, No. 4 (2011). “Global Quotas System and China’s Textile and Clothing Industry.” China & World Economy, Vol. 14, No. 5 (2006). “When Will China’s Labor-Intensive Manufacturing Lose its Competitive Edge.” International Economic Review, 4 (2010). “WTO Rules and Industrial Development in Large Developing Countries.” World Economics and Politics, 9 (2007). Huang Haizhou (黄海洲), Ph.D. (1994) in Economics and Finance, Kelley School of Business at Indiana University, is the Chief Strategist, Managing Director, and Executive Chairman of the Research Committee and Co-Head of the Research Department at the China International Capital Corporation (CICC). He has over twenty years’ experience in conducting research at market, policy and academic institutions. Dr. Huang Haizhou is also a Fellow of China Finance 40 Forum (CF40) as well as a Vice President of The China Society of World Economics. His main research interests include global macroeconomics and finance. Selected Publications of Huang Haizhou: Huang Haizhou and Charles Goodhart. “The Lender of Last Resort.” Journal of Banking and Finance, Vol. 29 (2005). Huang Haizhou and Shang-Jin Wei. “Monetary Policies for Developing Countries: The Role of Corruption.” Journal of International Economics, Vol. 70 (2006). Huang Haizhou and Shuilin Wang. “Foreign Exchange Regimes: China’s Experience and Choices.” China Economic Review, 15 (2004). “New Contents and a New Policy of Reform and Opening Up.” Comparative, 2 (2009). “On the US Dollar and Renminbi: Some Forward-Looking Perspectives.” International Economic Review, 2 (2010). “RMB’s Internationalization: A New Drive for Further Reforms.” International Economic Review, 4 (2009). “When Will the US Economy Resume High-Rate Growth?” International Economic Review, 1 (2011). Zhu Min (朱民), Ph.D. (1990) in Economics, Johns Hopkins University, is the Deputy Managing Director of the International Monetary Fund and Vice President of the China Society of World Economy. He served as Special Advisor to the Managing Director of the International Monetary Fund from May 3, 2010 to July 25, 2011. Mr. Zhu, a native of China, was a Deputy Governor of the People’s Bank of China. He was responsible for international affairs, policy research, and credit information. He held various positions at the Bank of China where he served as Group Executive Vice President, responsible for finance and treasury, risk management, internal control, legal and compliance, and strategy and research. Mr. Zhu also worked at the World Bank and taught economics at both Johns Hopkins University and Fudan University. Selected Publications of Zhu Min: “A Changing World.” International Economic Review, 6 (2012). “Challenge of the Crisis – The Global Financial Crisis, the Government’s Criticism of Government Relief Measures.” Studies of International Finance, 2 (2009). “Five Issues of World’s Economic and Financial Structure in the Post-crisis Era.” International Economic Review, 4 (2009). “Ten Big Changes in the Global Financial Landscape after the Crisis.” Studies of International Finance, 1 (2010).



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Wang Yizhou (王逸舟), Ph.D. (1988) in Law, Chinese Academy of Social Sciences (CASS), is Professor and Associate Dean of the School of International Relations at Peking University as well as the Vice Chairman of China National Association for International Studies. He served as the Deputy Director of the Institute of World Economic and Politics at CASS and the Chief-editor of World Economics and Politics. Wang Yizhou is one of the most ­influential scholars in the field of international relations. His main research interests include theory of international politics, international relations, diplomacy and international strategy of China in the new century. Selected Publications of Wang Yizhou: “China’s Diplomacy: Some Thoughts and Prospects.” International Economic Review, 4 (2008). “Factor Analysis in China’s Diplomacy.” World Economics and Politics, 9 (2009). “Rethinking National Interests.” Social Sciences in China, 2 (2002). “Ten Features of China’s Diplomacy in a Reform Era.” World Economics and Politics, 5 (2008). Li Wei (李薇), Ph.D. (1996) in Law, Chinese Academy of Social Sciences (CASS), is Professor and Director of the Institute of Japanese Studies at CASS. She has been the secretary general of Japanese Law Research Center at the Institute of Law, CASS, since 1992. She served as Deputy Director of Bureau of International Cooperation, CASS from 1998–2008. Her main research interests include Japanese civil law and Japanese economy. Selected Publications of Li Wei: “Japan’s Financial Reconstruction.” Journal of World Economy, 10 (1997). “Japan’s Non-Performing Loans and ‘Financial Revitalization Overall Program.’” World Economics and Politics, 10 (1998). Japanese Traffic Accident Compensation for Personal Injury Legal System. Law Press, 1997. “Significant Changes in Japan’s Macroeconomic Policy.” International Economic Review, 04 (1998). “Yen slump and the influence of the Asian economy.” Studies of International Finance, 08 (1998). Yu Yongding (余永定), Ph.D. (1994) in Economics, University of Oxford, is the first academician of the Chinese Academy of Social Sciences (International Studies). He is Editorin-Chief of China and World Economy; member of the Advisory Committee of National Planning of the National Development and Reform Committee of the People’s Republic of China; member of the Advisory Committee of Foreign Policy of the Ministry of Foreign Affairs of China. Dr. Yu was Director-General of the Institute of World Economics and Politics (IWEP), CASS (1998–2009); President of the China Society of World Economy (2003–2011); and member of the Monetary Policy Committee of People’s Bank of China (2004–2006). His main research interests include macroeconomics, international finance and world economy. Selected Publications of Yu Yongding: “The Current RMB Exchange Rate Volatility and RMB Internationalization.” International Economic Review, 1 (2012). “From European Sovereign Debt Crisis to a Possible Global Sovereign Debt.” International Economic Review, 6 (2010). “The Nature, Causes and Solutions of the Double Surplus in China.” The Journal of World Economy, 3 (2006). “On the Derivation of Aggregate Supply Curve by Integration.” Economic Research Journal, 9 (2002). “Witness Imbalances—Twin Surpluses, Renminbi Exchange Rate and the Dollar Trap.” International Economic Review, 3 (2010).

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Zhang Bin (张斌), Ph.D. (2003) in Economics, Chinese Academy of Social Sciences (CASS), is Professor and Head of the Department of Global Macroeconomics in the Institute of World Economics and Politics (IWEP) at CASS. He was a visiting scholar at the Center for International Development, Harvard University (2006–2007) and a visiting researcher in the United Nations Conference on Trade and Development Secretariat (2005). Dr. Zhang Bin’s main research interests include exchange rate and international balance of payment, regional monetary cooperation, and China’s macroeconomic changes. Selected Publications of Zhang Bin: “An Analysis of Factors Influencing the Fluctuation of Nominal and Real Returns on China’s Foreign Exchange Reserves.” Social Sciences in China, 1 (2012). “China’s Production Sectors: History, Challenges and Required Reforms.” World Economy and China, Vol. 6 (2005). “The Consequences of Currency Appreciation: A Theoretical Model Based on Chinese Stylized Facts.” Economic Research Journal, 5 (2006). “Is ACU Attractive to East Asia Economies? The Case of China.” World Economy and China, Vol. 3 (2006). “Large Foreign Exchange Reserves and China’s Internal and External Economic Imbalances.” International Economic Review, 3 (2006). “RMB Exchange Rate Reform: A Trade-off Solution.” International Economic Review, 1 (2010). “RMB’s Real Exchange Rate: Concept, Measurement and Decomposition.” China Economic Quarterly, 3 (2005). “Should Asian Economies Hold More Asian Assets in Their Foreign Exchange Reserves— Answer from China.” Studies of International Finance, 3 (2011). Qiao Yide (乔依德) is the General Secretary of the Shanghai Development Research Foundation. His main research interests include international monetary system reform and RMB internationalization. Selected Publications of Qiao Yide: China’s Economy: The Next Three Decades. Shanghai: Gezhi Press, 9 (2011). China’s Urbanization: Goals, Policies and Path. Shanghai: Gezhi Press, 10 (2012). “Strengthening the Role of SDR in International Monetary System.” International Economic Review, 3 (2011). Zhang Weiying (张维迎), Ph.D. (1994) in Economics, University of Oxford, is Professor of Economics in the Guanghua School of Management at Peking University as well as Director of the Market Network Economic Research Center at the same university. He is also the Chief Economist of the China Entrepreneurs Forum. Zhang Weiying was the first Chinese economist to propose the “dual-track price system reform” (1984), which had a fundamental impact on the post-1985 price liberalization policy in China. His works have had a significant impact on the economic reform policy formulation and the development of economics in China. Dr. Zhang’s main research interests include industrial organization, corporate governance, information economics, and economic reform in China. Selected Publications of Zhang Weiying: “Enterprisers and Professional Handlers: How to Establish Trust.” Journal of Peking University (Humanities and Social Sciences), 5 (2003). Game Theory and Information Economics. Shanghai: Shanghai People’s Publishing, Nov. 2004. “Information, Incentive and Joint Responsibility: A Legal and Economic Interpretation of Lian Zuo and Bao jia Systems in Ancient China.” Social Sciences in China, 3 (2003). Logic of the Market. Shanghai: Shanghai People’s Publishing, Jul. 2010. Prices, Market Entrepreneurs. Beijing: Peking University Press, Jan. 2006. What Changes China. Beijing: CITIC Publishing, Jul. 2012.



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He Huaihong (何怀宏), Ph.D. (1988) in Philosophy, Renmin University of China, is Professor of Philosophy at Peking University and Director of Ethics Teaching and Research Office. Dr. He was a professor at the Institute of Chinese Studies (1995–1998), visiting scholar at Harvard University (1993–1994), and an associate professor at China Youth University for Political Science (1989–1995). His main research interests include ethics, philosophy of life, and social history. Selected Publications of He Huaihong: The Base Line of Ethics. Liaoning: Liaoning People’s Publishing, 1998. Casuistic: Social Transformation of Traditional Conscience. Shanghai: Joint Publishing, 1994. Concept of Confucian Equality and Institutionalized. Beijing: China Social Sciences Press, 1999. “Confucian Philosophy.” In Dialogue: Confucianism, Buddhism, Taoism and Christianity. Beijing: Social Sciences Academic Press, 1998. Contract Ethics and Social Justice: the History and Rational in Rawls’ Theory of Justice. Beijing: Renmin University Press, 1993. Election Social and Its End: A Sociological Interpretation From Qin and Han Dynasty to the Late Qing Dynasty History. Beijing: Joint Publishing, Harvard-Yenching Academic Books, 1998. Hereditary Societies and Its Disintegration: the Spring and Autumn Period in Chinese History. Beijing: Joint Publishing, Harvard-Yenching Academic Books, 1996. “If There is No God, how will the morality Likely?” Journal of Nanchang University (Humanities and Social Sciences), 1 (1999). “Kant’s theory of Reform and Obedience.” Joint Publishing, Oct. 1996. Meditation of Life: Pascal’s Commentary. China Federation of Literary and Art Circles Publishing Corporation, 1988. Yuan Yaxiang (袁亚湘), Ph.D. (1986) from the University of Cambridge, is Academician of the Chinese Academy of Social Sciences where he is also Professor in the Academy of Mathematics and Systems Science as well as in the Institute of Computational Mathematics and Scientific/Engineering Computing. He is also a member of the Society for Industrial and Applied Mathematics (SIAM) and a member of the International Institute of Mathematical Programming. Dr. Yuan was the former Vice-President of the Academy of Mathematics and System Sciences (1998–2007), former Director of the Institute of Computational Mathematics and Scientific/Engineering Computing (1995–2006) at CASS. His main research interests include computational mathematics, applied mathematics, operational research, and optimization computing methods. Selected Publications of Yuan Yaxiang: “A Counter-Example to a Conjecture of Ben-Tal, Nemirovski and Roos,” Journal of the Operations Research Society of China, Vol. 1 (2013). “Analysis on a Superlinearly Convergent Augmented Lagrangian method,” Accepted by Acta Mathematics Sinica, English Series. Fan, J.Y. and Yuan Yaxiang. “A regularized Newton method for monotone nonlinear equations and its application” Optimization Methods and Software (2013). Sun, C.; Y.C. Yang; and Yuan Yaxiang. “Low complexity interference alignment algorithms for desired signal power maximization problem of MIMO channels.” EURASIP Journal on Advances in Signal Processing (2012). Yuan Yaxiang; L.Q. Qi, Yi Xu and X.Z. Zhang. “A Cone Constrained Convex Program: Structure and Algorithms.” Journal of the Operations Research Society of China, Vol. 1 (2013).

Journal Information International Economic Review, launched by the Institute of World Economics and Politics, Chinese Academy of Social Sciences in 1996, is a policy review journal that focuses on international relations, economy and politics, and Chinese macroeconomics. It is highly reputed in China’s academic, political and industrial circles for its thoughtfulness, policy reference and academic standards. World Economics and Politics, launched by the Institute of World Economics and Politics, Chinese Academy of Social Sciences, in 1979, is a journal that focuses on theories of international relations. It adheres to the principle of combining studies of international politics and world economy. It also seeks to combine theory and practice and balance studies of domestic and international issues. The journal, devoted to improving the comprehensiveness, foresight and innovation of research, catches up with the latest development of relevant disciplines. China International Strategy Review, launched by the Center for International and Strategic Studies, Peking University, in 2008, is a yearly publication that focuses on the frontiers, subjects, main themes and theoretical bases of international strategic studies. It is centered on analyses of the international environment of modern China and the international strategies of relevant countries. Based on that, it publishes relevant research results that have future-oriented policy implications. Its editor-in-chief is Wang Jisi. Comparative Economic & Social System was launched in 2002. With the prominent economist Wu Jinglian as its editor-in-chief, the journal seeks to selectively introduce experiences and lessons of other countries, theories and practices of transitional economies and development in comparative studies to provide references for China to solve the problems it encounters during its reform and opening-up era. Incorporating the latest theoretical development, the journal also selectively introduces reform plan designs, policy suggestions and comments by domestic and international academic circles that target China’s economic reform. It is an important academic journal that focuses on discussions of international economics and China’s economic development. Foreign Affairs Review, launched by China Foreign Affairs University in 1984, seeks to publish the latest research results by experts and scholars regarding major international strategic issues, world situation, international relations theory, major development changes in regional and national politics, diplomacy, economics, science and technology, society, and military, world economy, and other major issues. While it maintains its advantage in policy influence, timeliness and academic standards, the journal keeps its academic depth by including theoretical studies. Articles in the journal have great influence on China’s academic and diplomatic decision-making circles. Studies of International Finance, launched by the China International Finance Society supervised by the Bank of China, in 1984, includes contributions from domestic and international experts, scholars and researchers who conduct systematic studies in international financial theories, strategies and policies. The journal, which includes studies of the latest theoretical development, also provides information and policy suggestions regarding the financial sector for the policymaking of the government.

INDEX Adjustments to the International Order 106, 109 Agreement on Textiles and Clothing (ATC) 115, 120 Arbitrage 237–238, 231–242, 245–247, 250–252 Asia-Pacific area 61 Balance 8–9, 16–17, 46, 48–49, 62, 78, 94, 107, 151, 164, 172, 181, 185, 189, 202, 218–219, 221–222, 228–229, 234–235, 248, 283, 303, 305 Balance of payments 37, 164, 218–219, 222, 228–229, 256, 260, 270 Balance sheet 45, 127, 129, 131, 133–135, 139–140, 143, 146, 149, 153, 251 Balanced development 217, 233 Beijing consensus 23, 283, 308 Beneficial factors 288–293 Brazil 19–21, 25, 38 n. 1, 46–47, 99, 118, 121, 157, 165–166, 283, 294 BRIC 165 Capability of further borrowing 136 Capital Account Control 9, 243 Capital control 9, 221, 223, 236, 231, 239, 243, 250, 252–253 Carry trade 237, 242, 245, 247 Center-periphery structure 79 Changing growth model 167, 174 Checks and balances 81–82 China model 23, 81, 83–86, 308 China’s economy 44, 49, 93–94, 109, 248 China’s international strategic environment 14, 29 China’s Responsibilities 5 China’s rise 6, 34–35, 94–95, 99, 109, 121–122, 293, 307 China’s role 5, 19, 45, 47, 52, 60, 112 China’s status 116–117, 276 China’s Surrounding Areas 59 Chinese overseas 193 Current account balance over GDP 49 Current account deficit 37, 149, 229, 235, 265 Debt crises 155–156 Defense White paper 195

De-peg 221–222, 227, 232, 291 De-suburbanization 40 Differentiated treatment rules 98 Domestic politics and international politics 73, 80, 83 Dualistic structure 41, 44 East Asian Community 90, 93–94 Economic cooperation 68, 87–88, 90–93, 101, 103 Economic development dilemma 151 Economic growth 8, 17, 20–21, 27, 31, 33, 57, 67, 75–76, 79, 84, 89–91, 92 n. 12, 94–95, 102–103, 121, 127–129, 135, 140–144, 146–163, 165–176, 185–187, 193, 199 n. 2, 219, 222, 224, 229, 257, 293, 302 Emerging Economies 4, 7, 34, 127, 136, 155–156, 158–174, 176–177, 187, 285 Energy issue 42, 150 Expenditure 38, 46 Public finance expenditure 46 External factors 8, 197–198, 210 Foreign Direct Investment (FDI) 34, 166, 233–235, 241, 249 Financial crisis 7, 30, 40, 45, 48, 52, 89, 121, 127–128 131, 134–135, 137–138, 145, 148, 155, 165–167, 173–174, 177, 217–218, 220–222, 228, 230–231, 235, 253, 256, 283, 291–292 Foreign exchange reserves 35, 42, 226, 229–232, 234, 291 Global Economic Recovery 7, 127–128, 131, 145, 151, 153, 155 Global economy 3, 38, 42, 48, 127–128, 131, 143, 149, 150–156, 158–160, 162–165, 173–176, 267, 272 Global financial crisis 89, 128–129, 134, 136–138, 141, 149, 153, 155–156, 167, 174, 247, 255–256, 302 Global governance 7, 18, 31, 105, 127, 140, 146, 152–153, 177, 293 Global leadership 285, 286–288 Global resource demand 160 Hedging strategy 94, 101 High deficit and high debt 141, 146, 151

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index

Historical reflections 197–198, 210, 212 Historical review 69 Imbalance 5, 17, 33, 37, 49, 84, 128, 149, 174–175, 187, 233, 235–236, 256–257, 264 India 19–21, 25, 40, 46–47, 56–57, 63–64, 91, 118–119, 121, 152, 165, 170, 183, 186–187, 283, 285, 287, 292–294 Internal factors 208 International Monetary Fund (IMF) 9, 44, 142–143, 156, 256–257, 261–278 International monetary system 9, 255–262, 264, 267, 269, 271–273, 275 n. 36, 278 International position 10, 22–23 International security 14, 195–196 Japanese yen appreciation 224 Limited Exchange rate 9 Lonely power 6, 68 Major powers 31, 72–73, 105, 109–111, 120, 123, 190, 264, 271, 284, 297  Relations among 70, 98, 109, 121 Marxism 71, 73, 81 Multilateral trading system 7, 105, 109–113, 115, 119–123 Multi-Fiber Agreement (MFA) 115, 120 Multi-level relationship mechanisms 59 National identity 8, 13, 19, 197–198, 203, 205, 213 National re-orientation 93–94, 101 New Challenges 7, 15, 59–60, 62–63, 167, 174, 294 Non-traditional security problem 68 Normal statehood 8, 197–198, 201–203, 212–213 North American Free Trade Agreement (NAFTA) 88 Offshore Market 237–245, 247, 250–253 Onshore Market 237–238, 241, 243–244, 250–252 Open regionalism 88, 98 Opportunity 10, 58–59, 63, 66–67, 92, 107, 109, 172–173, 182, 199–200, 211, 250, 289 Overall situation 6, 56, 60, 68 Over-consumption 37–38 Painful and complex adjustment 47

Peaceful development 28, 63, 72, 75, 184, 192, 213, 308 Peaceful rise 87, 101, 181, 183, 185, 188, 196 Plaza Conference 224 Policy tendencies 141 Preserving the Stability of the International Financial System  48, 50 Public goods 57, 61–62 “Return to Asia Pacific” Strategy 6, 87–88, 94–96, 99, 101, 103 Rate system 218, 220, 275 Rebalance 5, 7, 33, 153, 272 Regional monetary arrangement  260–261 Renminbi (RMB) Appreciation 8, 217, 221–230, 232, 237, 241–252 Exchange rate 8–9, 217–233, 236, 237–238, 240–248, 250–253 Internationalization 9, 53–54, 237–240, 250, 252, 273 Reserve currency 136, 255–258, 261–262, 264–266, 269, 271–273 Responsible and Active Leader 119 Rising power 6, 55, 61, 67–68, 83, 91 Russia 19–20, 25, 34, 56–57, 63, 68, 85, 88, 99, 111, 118, 157, 165, 183–187 Savings surplus countries 39 Science and technology 23, 27, 29, 31, 281, 295–299 SDR Basket 9, 255–256, 265, 267, 273–278 Security diplomacy 88 Security strategies 197–202 Self-identification 197, 204, 213 Separatism Tendencies 183 Short-term Capital Flows 250 South Africa 19, 25, 118, 119 South China Sea Predicament 188 South-South 164–165 Spaghetti Bowl effect 97–98 Stimulus policy 128–129, 141, 153, 156, 168 Strategy for doubling exports 89–90 Structural reforms 7, 127, 140, 146, 153, 155, 167 Super-sovereign currency reserve system 255, 259, 261



index

Taiwan 8, 27, 34, 36, 39, 181–187, 229, 303–304, 306 The Western order 69, 78–82, 86 The world order 69–71, 78, 81–82, 86, 285 Trade Deficit 46–48, 221–222, 228–229 Reducing the Trade Surplus 48 Surplus 33, 36, 39, 45–46, 48–49, 222–223, 228–230, 234–235, 249, 251 n. 27 Trans-Pacific Partnership (TPP) 6, 59, 87, 90 nn. 6–7 Twin Surpluses 234

337

United States and China 3, 5, 9, 33, 37, 94–95, 198, 202, 288, 291–294 Welfare 31, 46, 79, 143, 151, 229, 240, 244, 295, 302 Western Democracy 16, 79 Widening gap between the rich and the poor 257 World economy 2, 4, 33, 36–38, 41, 45, 47–49, 52–53, 70, 92, 152, 266, 272, 275, 292–294 World order 6, 69–71, 78, 81–82, 86, 107, 196, 202, 285 World Trade Organization (WTO) 45, 89 n. 4, 92, 96, 109–123, 165