Archive for the ‘China’ Category

Stratfor: China’s Ambitions in Xinjiang and Central Asia: Pt. 1

Thursday, October 3rd, 2013


September 30, 2013

Editor’s Note: This is a three-part series on China’s evolving strategic interests in Central Asia and in its own far northwest, the Xinjiang Uighur Autonomous Region. Part 1 looks at Xinjiang’s history as a "buffer region" protecting China’s core and linking it to Eurasia. This installment also examines recent efforts by Beijing to adapt the region’s legacies to new uses. Read more in Part 2 and Part 3.

In mid-September Chinese President Xi Jinping rounded out a 10-day tour of Central Asia that included state visits to Turkmenistan, Kazakhstan, Uzbekistan and Kyrgyzstan, as well the G-20 summit in St. Petersburg and the Shanghai Cooperation Organization summit in Bishkek. At each stop, the new president made hearty pledges of financial support and calls for further diplomatic, security and energy cooperation. In Turkmenistan, Xi inaugurated a natural gas field. In Kazakhstan, he agreed to invest $30 billion in energy and transportation projects. In Uzbekistan and Kyrgyzstan, he made similar promises to increase investment and cooperation in the coming years.

Xi’s tour can be examined as part of China’s struggle to reduce its exposure to security risks and supply disruptions off its coast by developing new overland transport routes for goods, energy and other natural resources. China’s eastern seaboard, and the maritime realm beyond it, have dominated Chinese political, economic and military planning in recent decades, and in many ways it will continue to do so for the foreseeable future. The coast will remain central to China’s role in the global economy, facilitating the flow of Chinese goods to overseas markets, as well as the imports of seaborne energy and raw materials relied upon heavily by coastal provinces to feed their oversized manufacturing bases.

In recent years, however, anxiety within the Chinese Communist Party over the security implications of the country’s dependence on coastal trade has taken many forms. China’s aggressive efforts to modernize its navy and expand energy, resource and infrastructure projects overseas are perhaps its most visible attempts to cope with the geopolitical implications of its economic and energy needs. Xi’s tour, along with several other recent events, has highlighted China’s enduring need to focus on westward development as well.

Establishing a ‘New Border’

Geographically, China consists of three shelves that radiate up and outward from east to west like the steps of an amphitheater. The first and second shelves essentially hover over the Han core, where more than 90 percent of China’s roughly 1.3 billion people live. Surrounded by plateaus, mountains, deserts and steppe, the core historically has been vulnerable to attack — whether from Mongolian horsemen riding down through the Central Eurasian plains, the Manchu descending from Eastern Siberia or the Japanese (in 1592 and again during World War II) through the Korean Peninsula and Manchuria.

Chinese Provinces and Central Asia

To defend the Han from overland invasion, successive Chinese dynasties have sought to push the core’s boundaries north and west by capturing and pacifying as much of the frontier highlands as possible. As a result, the history of Han China’s engagement with the sparsely populated, inhospitable lands on its periphery is defined by cycles of incorporation — with these regions transformed into protective buffers — and dispersal, whenever the core has fragmented and lost control of the frontier.

In many ways, Xinjiang represents the outer edge in this pattern. It is far more remote than other traditional buffer regions such as Inner Mongolia and Manchuria. Urumqi, the provincial capital, is more than 3,100 kilometers (1,920 miles) from Beijing, while Kashgar, the westernmost Chinese city and historically a major Silk Road trading hub, is nearly 4,400 kilometers from the coast. Xinjiang has also played a less-prominent role in Chinese history than the other buffer regions. Over the past 2,500 years, the region has broken away from China repeatedly, and it was not fully incorporated into the Chinese empire until the 18th century, taking the name Xinjiang, or "New Border," a century later. China’s conquest of Xinjiang under the Qing Dynasty (1644-1911) was in part a response to the rise of Russia as a Eurasian power during the same period. Prior to then, there had been little threat of invasion from Central Asia and hence little reason to formally annex all of Xinjiang.

Moreover, Xinjiang is largely a desert wasteland cleaved in two by the Tianshan Mountains. The majority of its 22 million inhabitants live clustered in one of three sub-regional cores: the Uighur-dominated Tarim Basin to the south (centered in Kashgar), the majority Han Chinese Junggar Basin to the north (home to Urumqi), and the smaller Ili River Valley wedged in between. Today, Xinjiang accounts for 17 percent of China’s total landmass — an area roughly half the size of India — but less than 2 percent of its population. The physical environment of the region is simply too harsh to support large populations (by Chinese standards), even with modern agricultural and industrial technologies.

The Silk Road

But Xinjiang is not entirely cursed by geography. It is the only major overland route from China to Central Asia and thus was historically part of the Silk Road trade routes. Long before Xinjiang became a military buffer for China, narrow passageways such as Alashankou, the Dzungarian Gate and the Karakoram Pass along the region’s borders with modern-day Kazakhstan and Pakistan shaped its economic, cultural and political identity as a commercial gateway to high-end goods such as silk, jade, spices and precious gems. The importance of trade along the Silk Road ebbed and flowed with changes in the Chinese economy and those of its major trading partners, and it has never accounted for more than a fraction of the Chinese Empire’s total economic output. Nonetheless, Xinjiang has long been important as a conduit for facilitating the exchange of ideas and technologies between China and the rest of Eurasia.

Modern Day: Building Trans-Eurasian Ties

In a speech in Astana, the Kazakh capital, on Sept. 7, Xi framed his tour as an effort to create a "Silk Road Economic Belt" through Xinjiang and the Central Asian states it borders, as well as Uzbekistan and Turkmenistan. Talk of re-establishing the historical trade route was promptly echoed by national and regional leaders in Xinjiang, who emphasized the region’s unique role as a land bridge to South and Central Asia.

Indeed, Xinjiang’s history as a trade route and protective buffer is still shaping Beijing’s interests and policies in the region today, especially as the Party looks to expand overland energy and trade ties with Central Asia. For Beijing, the challenges and opportunities presented by Xinjiang are manifold: As an energy transport corridor and resource base, the province will be critical for efforts to industrialize the interior and reduce China’s exposure to possible supply disruptions in the South and East China seas. At the same time, Xinjiang’s remoteness and terrain, as well as persistent security concerns about the region’s restive Uighur Muslim population, will constrain Beijing’s most ambitious visions of trans-Eurasian road, rail and pipeline systems.

Nonetheless, there are already an unprecedented number of cross-border projects under various stages of development. Many, such as a proposed agricultural free trade zone along the Xinjiang-Tajikistan border, are small and expected to have a limited long-term impact. Others, such as a long-discussed overland transport corridor linking Kashgar (which was made into a special economic zone in 2010 and has since emerged as a focal point for state-led investment in Xinjiang) with the Chinese-operated Port of Gwadar in Pakistan, could be much more geopolitically significantly, albeit while facing enormous logistical, political and security constraints in the near term.

China's Ambitions in Xinjiang and Central Asia: Part 1

One of the most promising developments in overland transport is the China-Europe railway. On July 17, Beijing inaugurated a direct rail line from Zhengzhou, the capital of Henan province and the largest inland manufacturing base for Taiwanese electronics firm Foxconn, to Hamburg, Germany. Six round trips are expected to be made on the Zhengzhou-Hamburg line in 2013, each one ferrying approximately $1.5 million-worth of mostly electronic goods to Europe. It takes around 21 days to reach the Continent by rail, while seaborne transport between China and Europe takes around five weeks, with much longer average delay times. Transport from inland China to Europe by rail costs approximately 25 percent more than by sea, but for companies such as HP (which has been shipping Chinese-assembled laptops to Europe from its Chongqing factories since 2011) and DHL (which now runs weekly express trains to Europe from Chengdu), the benefits of speed outweigh the extra costs.

Trade Booming, but Challenges Remain

The Chinese and Kazakh governments expect the volume of overland trade through the region to Europe to grow from 2,500 forty-foot equivalent units (a measurement of cargo capacity) this year to 7.5 million by the end of the decade, according to The New York Times. If value grows at the same rate, then overland trade between China and Europe could reach $4.5 billion — still only a small fraction of overall China-Europe trade, but one that will have tangible benefits in the inland cities most directly affected.

Still, efforts to develop overland transport routes to and through Central Asia will be constrained by distance, terrain and political and security risks — not only in the Eurasian states that new lines would pass through but within Xinjiang as well. Projects such as the Kashgar-Gwadar corridor will be easy targets for local separatists or jihadist elements with ties to the East Turkestan Islamic Movement in Xinjiang and Pakistan’s Waziristan region. Meanwhile, the China-Europe line will be vulnerable to shifts in Russian policy or in Moscow’s relations with other countries along the route, especially Kazakhstan, Belarus and Poland. Similar political, geographic and security challenges will complicate another long-discussed project, the Trans-Asia Railway (known colloquially as the Iron Silk Road) linking China to Europe via the Middle East.

China’s Growing Interest in Central Asia

Even if the large-scale development of trans-Eurasian transport links is ultimately constrained, Beijing’s support for such projects is telling nonetheless and indicative of China’s broader strategic concerns. As a transport corridor, Central Asia is unlikely to ever account for more than 5-7 percent of Chinese-European trade by volume, but it will support the Party’s broader goal of curtailing, to whatever extent possible, China’s overreliance on sea-lanes in the South and East China Seas. Similar to planned oil and natural gas pipelines that will run from the coast of Myanmar to Yunnan and like the prospective Gwadar-Kashgar transport corridor, overland railways could serve as possible lifelines for arms, munitions and energy in the event of a security crisis on the coast. However remote this possibility, China’s leaders are not insensitive to it, especially given the modern legacy of war and invasion from the east.

Next: Part 2 of this series examines more closely Beijing’s expansion of energy ties to Central Asia, as well as its efforts to transform Xinjiang into a resource supply hub.

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Stratfor : China’s Hopes for Bridging the Taiwan Strait

Friday, August 9th, 2013


August 7, 2013


Taiwanese missile boats patrol the Taiwan Strait during a military drill in May. (SAM YEH/AFP/Getty Images)


More than six decades after Taiwan’s estrangement from mainland China, the Taiwan Strait still represents the most physically formidable and symbolically inaccessible barrier to Beijing’s objective of eventual reunification with the island. Over the course of its history, Taiwan switched hands from European and Japanese colonial occupiers before becoming the prospective battleground between China and Taiwan in the second half of the 20th century. In recent years, military tensions between China and Taiwan have eased, and Beijing hopes that enhanced economic integration and the physical infrastructure it wants to build one day across the Taiwan Strait could bring the country a step closer to fulfilling a core geopolitical imperative by reuniting with the island.


The South China Morning Post reported Aug. 5 that in its recently approved National Highway Network Plan for 2013-2030, the State Council included two highway projects linking Taiwan to the mainland. One involves the long-proposed Beijing-Taipei Expressway, which would start in Beijing and pass through Tianjin, Hebei, Shandong, Jiangsu, Anhui, Zhejiang and Fujian’s Fuzhou before crossing the strait and reaching Taipei. Another inland route would start in Chengdu and pass through Guizhou, Hunan, Jiangxi and Fujian’s Xiamen, and cross the Taipei-administered Kinmen archipelago before eventually ending at Kaohsiung in southern Taiwan.

China's Proposed Cross-Strait Infrastructure

The plan does not specify what kind of infrastructure — a bridge or a tunnel, for example — would be used to connect the mainland to Taiwan over the 180-kilometer (111-mile) strait, but since 1996, if not earlier, Beijing has publicly called for such infrastructure to be built. One proposal involved a 122-kilometer undersea tunnel, which was deemed preferable because of its relative seismic stability and its location in shallower water. This tunnel would connect Fujian province’s Pingtan Island to Hsinchu in northern Taiwan — a distance nearly three times that of Channel Tunnel, which connects the United Kingdom and France — and would cost an estimated 400 billion-500 billion yuan ($65 billion-$81 billion) to build. Another proposal involves linking Taiwan’s southern Chiayi county to the outlying island of Kinmen via tunnel or bridge, where it would connect with envisaged infrastructure that would eventually link it to Xiamen, Fujian province. 

Besides the massive economic costs associated with building a bridge or tunnel across the Taiwan Strait, security concerns, geologic vulnerabilities (due to earthquakes) and the sheer width of the strait present technical challenges to its construction. Even if the infrastructure were built, it is not clear that they would be economically justifiable given that airliners and ships are now allowed to travel across the strait frequently.

For decades, China and Taiwan had no official interaction at all, and infrastructure linking the two was something only Beijing wanted. Taipei viewed any bridge or tunnel link as a potential security liability, since it could enable easier access to the island by mainland military forces in times of crisis. While tensions have thawed in recent years, talks between the two sides still only involve economic and cultural issues, not political issues. Combined with logistical challenges, the absence of direct relations between the two makes it extremely unlikely that the infrastructure will built any time soon.

Though a bridge or tunnel link remains largely illusory, Beijing’s hope to bridge the gap — both physically and symbolically — across the Taiwan Strait was brought a bit closer to reality in early July, when Beijing and Taipei finalized a plan to supply water from the mainland to Kinmen, an outlying Taiwanese island less than 3 kilometers from the coast at Fujian. Under the plan, which was long opposed by Taipei and took 10 years of negotiations to resolve, water would be sent from Fujian province to Kinmen at its narrowest point.

To alleviate the island’s lingering water shortage, two possible pipeline routes were proposed, one involving a 26.8-kilometer pipeline directing water from Jinji reservoir in Fujian’s Jinjiang to Kinmen, and one involving a 30 kilometer-long pipeline, nearly 9 kilometers of which would be undersea, connecting the Jiulong River in Xiamen and the city’s Tingxi reservoir. (The latter was the preferred route.) This water pipeline would be the first cross-strait infrastructure link. Significantly, China has pursued the project even though Fujian province itself is suffering from a lingering water shortage, making clear how strategically important Beijing views a physical link with Taiwan. During negotiations, discussions resurfaced of constructing a bridge between Kinmen and Xiamen.

Compared to the much more ambitious proposal to link the mainland to Taiwan via bridge or tunnel, the pipeline with Kinmen is not in itself very significant. However, it does offer an example of Beijing sacrificing what is superficially pragmatic for the sake of its strategic goals. In particular, Kinmen had once been the leading military frontier until the end of cross-strait military standoff in 1992, and Beijing believes that assisting the island can offer an example of cross-strait integration. Beijing also believes it could allow more Taiwanese residents to benefit from growing economic interaction with China without undermining Taipei’s political independence.

Symbolic Steps

Warming cross-strait ties have coincided, and indeed complemented, China’s attempt to project economic influence externally, including with Taiwan. Coupled with Beijing’s vastly superior military capabilities, the economic incentives for cross-strait cooperation have formed the backbone of its less overtly aggressive stance toward the island in the past decade. While reunification remains the ultimate goal, it has been widely acknowledged among Beijing’s political elites that, as long as the possibility of peaceful reunification remains, there is little urgency or strategic necessity in forcing a final resolution unless a serious crisis emerges between Taiwan and China.

Instead, Beijing is focusing on a more conciliatory approach to reinforce the concept of interdependence and prevent Taiwan from distancing itself from the mainland economically and politically. At least for now, Taipei appears to have reconciled this approach with its own so-called "economic first, politics later" strategy toward the mainland. This strategy allows it to benefit from economic cooperation with China and create a relatively calm environment that would benefit Taipei’s development without threatening its independent identity.

Beijing’s emphasis on interdependence has some merit, too. Over the years, China has benefited from easing restrictions on commerce and cultural exchanges with Taiwan, along with Taiwanese investment that has helped it upgrade its industrial sector. A less hostile government in Taipei has also been important for Beijing’s political legitimacy internationally. Moreover, China allowed a much more open market and more preferential trade and investment policies to Taiwan than the island nation would find elsewhere. Currently, trade with China and Hong Kong accounts for nearly a third of Taiwan’s economy, in part helping the island avoid further decline amid the global slowdown.

Since reunification is always going to be an imperative for Beijing until it actually takes place, the proposed infrastructure is an important step symbolically for its integration strategy. Trade patterns can change rapidly, and interests there can shift — especially now that the Chinese economy itself is undergoing massive internal changes. Consequently, a pipeline or tunnel may not be especially important in themselves and may even be unrealistic and impractical, but taken with the other developments, they point to a new type of strategic thinking in Beijing.

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International Crisis Group: China’s Central Asia Problem

Sunday, August 4th, 2013


Bishkek/Beijing/Brussels  |   27 Feb 2013

China’s influence is growing rapidly in Central Asia at a time when the region is looking increasingly unstable.

China’s Central Asia Problem, the latest report from the International Crisis Group, examines Beijing’s strong relationship with its neighbours in that troubled region (Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan and Uzbekistan). Already the dominant economic force in the region, it could soon become the pre-eminent external power there, overshadowing Russia and the U.S.

But the Central Asian republics are increasingly beset by domestic problems. They are also vulnerable to a potentially well-organised insurgent challenge. Jihadists currently fighting beside the Taliban may re-focus their interest on the region after the 2014 NATO withdrawal from Afghanistan. Many in Beijing are alarmed by the range of challenges Central Asia faces. 

“China’s strategy seems to be the creation of close ties with Central Asia to reinforce economic development and stability, which it believes will insulate itself, including its Xinjiang Uighur Autonomous Region, as well as its neighbours from any negative consequence of NATO’s 2014 withdrawal from Afghanistan. It also hopes that economic development will counteract growing dissatisfaction with the political status quo in each country”, says Deirdre Tynan, Crisis Group’s Central Asia Project Director.

“The problem is that large parts of Central Asia look more insecure and unstable by the year. Afghanistan is a complicating factor, but many of Central Asia’s problems are the result of poor governance”, Tynan adds.

Since the collapse of the Soviet Union, China and its Central Asian neighbours have strengthened relations, initially on the economic front but increasingly on political and security matters as well. Central Asia’s socio-economic and political problems make it prone to turmoil and vulnerable to extremist organisations, both foreign and domestically generated.

Instability or conflict in one or more of the Central Asian states would impact China, as its economic interests depend on a stable security landscape. China’s investments are exposed not only to potential security crises but also to political whims of autocrats and grassroots violence.

China is starting to take tentative political and security initiatives in the region, mostly through the Shanghai Cooperation Organisation (SCO). However, the SCO, which includes Russia as well as the five Central Asian states, has shown itself ineffective in times of unrest. Central Asia’s international partners, including Russia and China, must be wary of attempts by the region’s leaders to push their populations to the brink, be it through political repression, divisive nationalism or economic deprivation. To address these threats, Beijing and Moscow need to view each other with less suspicion.

“China’s business practices in the region are driving suspicions of its intentions to an all-time high”, says Stephanie Kleine-Ahlbrandt, Crisis Group’s China Adviser. “If Chinese economic expansionism continues to fail to deliver benefits to the working population and enriches only certain political families, this could contribute to regional instability”.



Stratfor – The PC16: Identifying China’s Successors By George Friedman

Tuesday, July 30th, 2013


Tuesday, July 30, 2013

By George Friedman

Editor’s Note: For more information on purchasing the full PC16 report, which assesses each member of the grouping, and for details on custom briefings and analysis for your organization, please click here.

China has become a metaphor. It represents a certain phase of economic development, which is driven by low wages, foreign appetite for investment and a chaotic and disorderly development, magnificent in scale but deeply flawed in many ways. Its magnificence spawned the flaws, and the flaws helped create the magnificence.

The arcs along which nations rise and fall vary in length and slope. China’s has been long, as far as these things go, lasting for more than 30 years. The country will continue to exist and perhaps prosper, but this era of Chinese development — pyramiding on low wages to conquer global markets — is ending simply because there are now other nations with even lower wages and other advantages. China will have to behave differently from the way it does now, and thus other countries are poised to take its place.

Reshaping International Order

Since the Industrial Revolution, there have always been countries where comparative advantage in international trade has been rooted in low wages and a large work force. If these countries can capitalize on their advantages, they can transform themselves dramatically. These transformations, in turn, reorganize global power structures. Karl Kautsky, a German socialist in the early 1900s, wrote: "Half a century ago, Germany was a miserable, insignificant country, if her strength is compared with that of the Britain of that time; Japan compared with Russia in the same way. Is it conceivable that in 10 or 20 years’ time the relative strength will have remained unchanged?" Lenin also saw these changes, viewing them as both progressive and eventually revolutionary. When Kautsky and Lenin described the world, they did so to change it. But the world proved difficult to change. (It is ironic that two of the four BRIC countries had been or still are Communist countries.)

When it is not in the throes of war, trade reshapes the international order. After World War II, Germany and Japan climbed out of their wreckage by using their skilled, low-wage labor to not only rebuild their economy but to become great exporting powers. When I was a child in the 1950s, "Made in Japan" meant cheap, shoddy goods. By 1990, Japan had reached a point where its economic power did not rest on entry-level goods powered by low wages but by advanced technology. It had to move away from high growth to a different set of behaviors. China, like Japan before it, is confronted by a similar transition.

Post-China 16: Emerging Economies

The process is fraught with challenges. At the beginning of the process, what these countries have to sell to their customers is their relative poverty. Their poverty allows them to sell labor cheaply. If the process works and the workers are disciplined, investment pours in to take advantage of the opportunities. Like the investors, local entrepreneurs prosper, but they do so at the expense of the workers, whose lives are hard and brutal.

It’s not just their work; it’s their way of life. As workers move to factories, the social fabric is torn apart. But that rending of life opens the door for a mobile workforce able to take advantage of new opportunities. Traditional life disappears; in its place stand the efficiencies of capitalism. Yet still the workers come, knowing that as bad as their lot is, it is better than it once was. American immigration was built on this knowledge. The workers bought their willingness to work for long hours and low wages. They knew that life was hard but better than it had been at home, and they harbored hopes for their children and with some luck, for themselves.

As the process matures, low wages rise — producing simple products for the world market is not as profitable as producing more sophisticated products — and the rate of growth slows down in favor of more predictable profits from more complex goods and services. All nations undergo this process, and China is no exception. This is always a dangerous time for a country. Japan handled it well. China has more complex challenges.

The PC16

Indeed, China is at the fringes of its low-wage, high-growth era. Other countries will replace it. The international system opens the door to low-wage countries with appropriate infrastructure and sufficient order to do business. Low-wage countries seize the opportunity and climb upon the escalator of the international system, and with them come the political and business elite and the poor, for whom even the brutality of early industrialism is a relief.

But identifying these countries is difficult. Trade statistics won’t capture the shift until after it is well underway. In some of these countries, such as Vietnam and Indonesia, this shift has been taking place for several years. Though they boast more sophisticated economies than, say, Laos and Myanmar, they can still be considered members of what we are calling the Post-China 16, or PC16 — the 16 countries best suited to succeed China as the world’s low-cost, export-oriented economy hub.

In general, we are seeing a continual flow of companies leaving China, or choosing not to invest in China, and going to these countries. This flow is now quickening. The first impetus is the desire of global entrepreneurs, usually fairly small businesses themselves, to escape the increasingly non-competitive wages and business environment of the previous growth giant. Large, complex enterprises can’t move fast and can’t use the labor force of the emerging countries because it is untrained in every way. The businesses that make the move are smaller, with small amounts capital involved and therefore lower risk. These are fast moving, labor-intensive businesses who make their living looking for the lowest cost labor with some organization, some order and available export facilities.

In looking at this historically, two markers showed themselves. One is a historical first step: garment and footwear manufacturing, a highly competitive area that demands low wages but provides work opportunities that the population, particularly women, understand in principle. A second marker is mobile phone assembly, which requires a work force that can master relatively simple operations. Price matters greatly in this ruthlessly competitive market.

Therefore we tried to determine places where these businesses are moving. We were not looking for the kind of large-scale movements that would be noticed globally, but the first movements that appear to be successful. Where a handful of companies are successful, others will follow, so long as there is labor, some order and transportation. Some things are not necessary or expected. The rule of law, understood in Anglo-Saxon terms of the written law, isn’t there at this stage. Things are managed through custom and relationships with the elite. Partnerships are established. Frequently there is political uncertainty, and violence may have recently occurred. These are places that are at the beginning of their development cycle, and they may not develop successfully. Investors here are risk takers — otherwise they wouldn’t be here.

The beginning of China’s boom is normally thought of as 1978-1980. The Cultural Revolution had ended a few years before. It was a national upheaval of violence with few precedents. Mao Zedong died in 1976, and there had been an intense power struggle, with Deng Xiaoping consolidating power in 1977. China was politically unstable, had no clear legal system, sporadic violence and everything else that would make it appear economically hopeless. In fact, Egbert F. Dernberger and David Fasenfest of the University of Michigan wrote a paper for the Joint Economic Committee of Congress titled "China’s Post-Mao Economic Future." In this paper, the authors state: "In the next seven years as a whole, the rate of industrial investment and production, more than the total of the last 28 years, imply a level of imports and industrial labor force such that the exports, transportation facilities, social overhead capital, energy and middle-level technical personnel requirements would exceed any realistic assessment of Chinese capabilities."

I don’t mean to criticize the authors. This was the reasonable, conventional wisdom at the time. It assumed that the creation of infrastructure and a managerial class was the foundation of economic growth. In fact in China, it was the result of economic growth. The same can be said for rule of law, civil society, transparency and the other social infrastructure that emerges out of the social, financial and managerial chaos that a low-wage economy almost always manifests. Low-wage societies develop these characteristics possibly out of the capital formation that low-wage exports generates. The virtues of advanced industrial society and the advantages of pre-industrial society don’t coincide.

There is no single country that can replace China. Its size is staggering. That means that its successors will not be one country but several countries, most at roughly the same stage of development. Taken together, these countries have a total population of just over 1 billion people. We didn’t aim for that; we realized it after we selected the countries.

The point to emphasize is that identifying the PC16 is not a forecast. It is a list of countries in which we see significant movement of stage industries, particularly garment and footwear manufacturing and mobile phone assembly. In our view, the dispersal of industries that we see as markers of early-stage economic growth is already underway. In addition, there are no extreme blocks to further economic growth, although few of these countries would come to mind as having low political risk and high stability — no more than China would have come to mind in 1978-1980. I should also note that we have excluded countries growing because of energy and mineral extraction. These countries follow different paths of development. The PC16 are strictly successors to China as low wage, underdeveloped countries with opportunities to grow their manufacturing sectors dramatically.

The new activity is focused on Africa, Asia and to a lesser extent, Latin America. When you look at map, much of this new activity is focused in the Indian Ocean Basin. The most interesting pattern is in the eastern edge of Sub-Saharan Africa: Tanzania, Kenya, Uganda and Ethiopia. Sri Lanka, Indonesia, Myanmar and Bangladesh are directly on the Indian Ocean. The Indochinese countries and the Philippines are not on the Indian Ocean, and even though I don’t want to overstate the centrality of the Indian Ocean, they are nearby. At the very least we can say that there are two ocean basins, the Indian Ocean and the South China Sea. You might want to read my colleague Robert D. Kaplan’s book Monsoon on this region.

There are some countries in Latin America: Peru, the Dominican Republic, Nicaragua and Mexico. A special word needs to be included on Mexico. The area north of Mexico City and south of the U.S. borderlands has been developing intensely in recent years. We normally would not include Mexico but the area in central-southern Mexico is large, populous and still relatively underdeveloped. It is in this area, which includes the states of Campeche, Veracruz, Chiapas and Yucatan, where we see the type of low-end development that fits our criteria. Mexico’s ability to develop its low-wage regions does not face the multitude of challenges China faces in doing the same with its interior.

All of this has to be placed in context. This is not the only growth process underway. It is most unlikely that all of these countries will succeed. They are not yet ready, with some exceptions, for advanced financial markets or quantitative modeling. They are entering into a process that has been underway in the world since the late 1700s: globalism and industrialism combined. It can be an agonizing process and many have tried to stop it. They have failed not because of their respective ruling classes, which would have the most to lose. It doesn’t take place because of multinational corporations. They come in later. It takes place because of profit-driven jobbers who know how to live with instability and corruption. It also takes place because of potential workers looking to escape their lives for what to them seems like a magnificent opportunity but for us seems unthinkable.

The parabola of economic development dictates that what has not yet risen will rise and eventually fall. The process unleashed in the Industrial Revolution does not seem to be stoppable. In our view, this is the next turning of the wheel.

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"The PC16: Identifying China’s Successors is republished with permission of Stratfor."

Stratfor: Recognizing the End of the Chinese Economic Miracle By George Friedman

Tuesday, July 23rd, 2013


Tuesday, July 23, 2013

By George Friedman

Major shifts underway in the Chinese economy that Stratfor has forecast and discussed for years have now drawn the attention of the mainstream media. Many have asked when China would find itself in an economic crisis, to which we have answered that China has been there for awhile — something not widely recognized outside China, and particularly not in the United States. A crisis can exist before it is recognized. The admission that a crisis exists is a critical moment, because this is when most others start to change their behavior in reaction to the crisis. The question we had been asking was when the Chinese economic crisis would finally become an accepted fact, thus changing the global dynamic.

Last week, the crisis was announced with a flourish. First, The New York Times columnist and Nobel Prize-recipient Paul Krugman penned a piece titled "Hitting China’s Wall." He wrote, "The signs are now unmistakable: China is in big trouble. We’re not talking about some minor setback along the way, but something more fundamental. The country’s whole way of doing business, the economic system that has driven three decades of incredible growth, has reached its limits. You could say that the Chinese model is about to hit its Great Wall, and the only question now is just how bad the crash will be."

Later in the week, Ben Levisohn authored a column in Barron’s called "Smoke Signals from China." He wrote, "In the classic disaster flick ‘The Towering Inferno’ partygoers ignored a fire in a storage room because they assumed it has been contained. Are investors making the same mistake with China?" He goes on to answer his question, saying, "Unlike three months ago, when investors were placing big bets that China’s policymakers would pump cash into the economy to spur growth, the markets seem to have accepted the fact that sluggish growth for the world’s second largest economy is its new normal."

Meanwhile, Goldman Sachs — where in November 2001 Jim O’Neil coined the term BRICs and forecast that China might surpass the United States economically by 2028 — cut its forecast of Chinese growth to 7.4 percent.

The New York Times, Barron’s and Goldman Sachs are all both a seismograph of the conventional wisdom and the creators of the conventional wisdom. Therefore, when all three announce within a few weeks that China’s economic condition ranges from disappointing to verging on a crash, it transforms the way people think of China. Now the conversation is moving from forecasts of how quickly China will overtake the United States to considerations of what the consequences of a Chinese crash would be.

Doubting China

Suddenly finding Stratfor amid the conventional wisdom regarding China does feel odd, I must admit. Having first noted the underlying contradictions in China’s economic growth years ago, when most viewed China as the miracle Japan wasn’t, and having been scorned for not understanding the shift in global power underway, it is gratifying to now have a lot of company. Over the past couple of years, the ranks of the China doubters had grown. But the past few months have seen a sea change. We have gone from China the omnipotent, the belief that there was nothing the Chinese couldn’t work out, to the realization that China no longer works.

It has not been working for some time. One of the things masking China’s weakening has been Chinese statistics, which Krugman referred to as "even more fictional than most." China is a vast country in territory and population. Gathering information on how it is doing would be a daunting task, even were China inclined to do so. Instead, China understands that in the West, there is an assumption that government statistics bear at least a limited relationship to truth. Beijing accordingly uses its numbers to shape perceptions inside and outside China of how it is doing. The Chinese release their annual gross domestic product numbers in the third week of January (and only revise them the following year). They can’t possibly know how they did that fast, and they don’t. But they do know what they want the world to believe about their growth, and the world has believed them — hence, the fantastic tales of economic growth.

China in fact has had an extraordinary period of growth. The last 30 years have been remarkable, marred only by the fact that the Chinese started at such a low point due to the policies of the Maoist period. Growth at first was relatively easy; it was hard for China to do worse. But make no mistake: China surged. Still, basing economic performance on consumption, Krugman notes that China is barely larger economically than Japan. Given the compounding effects of China’s guesses at GDP, we would guess it remains behind Japan, but how can you tell? We can say without a doubt that China’s economy has grown dramatically in the past 30 years but that it is no longer growing nearly as quickly as it once did.

China’s growth surge was built on a very unglamorous fact: Chinese wages were far below Western wages, and therefore the Chinese were able to produce a certain class of products at lower cost than possible in the West. The Chinese built businesses around this, and Western companies built factories in China to take advantage of the differential. Since Chinese workers were unable to purchase many of the products they produced given their wages, China built its growth on exports.

For this to continue, China had to maintain its wage differential indefinitely. But China had another essential policy: Beijing was terrified of unemployment and the social consequences that flow from it. This was a rational fear, but one that contradicted China’s main strength, its wage advantage. Because the Chinese feared unemployment, Chinese policy, manifested in bank lending policies, stressed preventing unemployment by keeping businesses going even when they were inefficient. China also used bank lending to build massive infrastructure and commercial and residential property. Over time, this policy created huge inefficiencies in the Chinese economy. Without recessions, inefficiencies develop. Growing the economy is possible, but not growing profitability. Eventually, the economy will be dragged down by its inefficiency.

Inflation vs. Unemployment

As businesses become inefficient, production costs rise. And that leads to inflation. As money is lent to keep inefficient businesses going, inflation increases even more markedly. The increase in inefficiency is compounded by the growth of the money supply prompted by aggressive lending to keep the economy going. As this persisted over many years, the inefficiencies built into the Chinese economy have become staggering.

The second thing to bear in mind is the overwhelming poverty of China, where 900 million people have an annual per capita income around the same level as Guatemala, Georgia, Indonesia or Mongolia ($3,000-$3,500 a year), while around 500 million of those have an annual per capita income around the same level as India, Nicaragua, Ghana, Uzbekistan or Nigeria ($1,500-$1,700). China’s overall per capita GDP is around the same level as the Dominican Republic, Serbia, Thailand or Jamaica. Stimulating an economy where more than a billion people live in deep poverty is impossible. Economic stimulus makes sense when products can be sold to the public. But the vast majority of Chinese cannot afford the products produced in China, and therefore, stimulus will not increase consumption of those products. As important, stimulating demand so that inefficient factories can sell products is not only inflationary, it is suicidal. The task is to increase consumption, not to subsidize inefficiency.

The Chinese are thus in a trap. If they continue aggressive lending to failing businesses, they get inflation. That increases costs and makes the Chinese less competitive in exports, which are also falling due to the recession in Europe and weakness in the United States. Allowing businesses to fail brings unemployment, a massive social and political problem. The Chinese have zigzagged from cracking down on lending by regulating informal lending and raising interbank rates to loosening restrictions on lending by removing the floor on the benchmark lending rate and by increasing lending to small- and medium-sized businesses. Both policies are problematic.

The Chinese have maintained a strategy of depending on exports without taking into account the operation of the business cycle in the West, which means that periodic and substantial contractions of demand will occur. China’s industrial plant is geared to Western demand. When Western demand contracted, the result was the mess you see now.

The Chinese economy could perhaps be growing at 7.4 percent, but I doubt the number is anywhere near that. Some estimates place growth at closer to 5 percent. Regardless of growth, the ability to maintain profit margins is rarely considered. Producing and selling at or even below cost will boost GDP numbers but undermines the financial system. This happened to Japan in the early 1990s. And it is happening in China now.

The Chinese can prevent the kind of crash that struck East Asia in 1997. Their currency isn’t convertible, so there can’t be a run on it. They continue to have a command economy; they are still communist, after all. But they cannot avoid the consequences of their economic reality, and the longer they put off the day of reckoning, the harder it will become to recover from it. They have already postponed the reckoning far longer than they should have. They would postpone it further if they could by continuing to support failing businesses with loans. They can do that for a very long time — provided they are prepared to emulate the Soviet model’s demise. The Chinese don’t want that, but what they do want is a miraculous resolution to their problem. There are no solutions that don’t involve agony, so they put off the day of reckoning and slowly decline.

China’s Transformation

The Chinese are not going to completely collapse economically any more than the Japanese or South Koreans did. What will happen is that China will behave differently than before. With no choices that don’t frighten them, the Chinese will focus on containing the social and political fallout, both by trying to target benefits to politically sensitive groups and by using their excellent security apparatus to suppress and deter unrest. The Chinese economic performance will degrade, but crisis will be avoided and political interests protected. Since much of China never benefited from the boom, there is a massive force that has felt marginalized and victimized by coastal elites. That is not a bad foundation for the Communist Party to rely on.

The key is understanding that if China cannot solve its problems without unacceptable political consequences, it will try to stretch out the decline. Japan had a lost decade only in the minds of Western investors, who implicitly value aggregate GDP growth over other measures of success such as per capita GDP growth or full employment. China could very well face an extended period of intense inwardness and low economic performance. The past 30 years is a tough act to follow.

The obvious economic impact on the rest of the world will fall on the producers of industrial commodities such as iron ore. The extravagant expectations for Chinese growth will not be met, and therefore expectations for commodity prices won’t be met. Since the Chinese economic failure has been underway for quite awhile, the degradation in prices has already happened. Australia in particular has been badly hit by the Chinese situation, just as it was by the Japanese situation a generation ago.

The Chinese are, of course, keeping a great deal of money in U.S. government instruments and other markets. Contrary to fears, that money will not be withdrawn. The Chinese problem isn’t a lack of capital, and repatriating that money would simply increase inflation. Had the Chinese been able to put that money to good use, it would have never been invested in the United States in the first place. The outflow of money from China was a symptom of the disease: Lacking the structure to invest in China, the government and private funds went overseas. In so doing, Beijing sought to limit destabilization in China, while private Chinese funds looked for a haven against the storm that was already blowing.

Rather than the feared repatriation of funds, the United States will continue to be the target of major Chinese cash inflows. In a world where Europe is still reeling, only the United States is both secure and large enough to contain Chinese appetites for safety. Just as Japanese investment in the 1990s represented capital flight rather than a healthy investment appetite, so the behavior we have seen from Chinese investors in recent years is capital flight: money searching for secure havens regardless of return. This money has underpinned American markets; it is not going away, and in fact more is on the way.

The major shift in the international order will be the decline of China’s role in the region. China’s ability to project military power in Asia has been substantially overestimated. Its geography limits its ability to project power in Eurasia, an endeavor that would require logistics far beyond China’s capacity. Its naval capacity is still limited compared with the United States. The idea that it will compensate for internal economic problems by genuine (as opposed to rhetorical) military action is therefore unlikely. China has a genuine internal security problem that will suck the military, which remains a domestic security force, into actions of little value. In our view, the most important shift will be the re-emergence of Japan as the dominant economic and political power in East Asia in a slow process neither will really want.

China will continue to be a major power, and it will continue to matter a great deal economically. Being troubled is not the same as ceasing to exist. China will always exist. It will, however, no longer be the low-wage, high-growth center of the world. Like Japan before it, it will play a different role.

In the global system, there are always low-wage, high-growth countries because the advanced industrial powers’ consumers want to absorb goods at low wages. Becoming a supplier of those goods is a major opportunity for, and disruptor to, those countries. No one country can replace China, but China will be replaced. The next step in this process is identifying China’s successors.

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"Recognizing the End of the Chinese Economic Miracle is republished with permission of Stratfor."


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