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The Limits of China’s Economic Power

Dec. 25, 2017 Beijing’s efforts to coerce countries into doing what it wants have been ineffective.

This Week in Geopolitics

|December 25, 2017

Originally produced on Dec. 18, 2017 for Mauldin Economics, LLC

By Phillip Orchard

The countries of East Asia are worried about the coercive power of Beijing’s pocketbook. And perhaps they should be. China is flush with money, and as it continues to pour massive amounts of aid and investment into the region, it’s only a matter of time before Beijing tries to cash in.

China’s overseas investments are being pushed, at least in part, for strategic reasons. This is evident in the high number of projects included in China’s One Belt, One Road initiative that make little commercial sense and fail to perform their stated purpose: to bypass chokepoints that a hostile power could use to asphyxiate the Chinese. In areas such as the Philippines, the primary goal appears to be the cultivation of political influence in foreign capitals or, more cynically, the creation of dependence on Chinese investment or consumers, which Beijing could someday exploit.

But China’s capacity for economic coercion has as many limitations as it does strengths, as the case of South Korea shows. Tensions between the two countries revolve around the deployment of the US Terminal High-Altitude Area Defense anti-missile system in South Korea. Fearing that the THAAD system’s powerful radar could penetrate deep into Chinese territory and threaten its ability to respond to missile attack, Beijing opposed the deployment. And it was compelled to do something about it.

What resulted was a set of informal retaliatory measures that amounted to sanctions in everything but name. For example, Lotte Group, a major conglomerate that owned the land where THAAD was deployed, saw a number of its superstores in China closed, ostensibly over fire safety concerns. Hundreds of other South Korean firms working in China claim to have been subjected to a surge in inspections, visa denials, and increased customs hurdles. Sales of South Korean automobiles in China dropped roughly 44%. Beijing also banned package tours to South Korea, leading to a 50% drop in Chinese visitors through the first 10 months of 2017 (compared to the same period a year earlier). The hit to tourism alone is expected to cost the South Korean economy more than $5 billion. All told, the THAAD issue dented South Korean gross domestic product by 0.4 percentage points this year, according to Bank of Korea estimates.

But for Beijing, the whole effort has been utterly fruitless… and possibly counterproductive. THAAD deployment was completed in September. As a result, last month, Beijing effectively surrendered its position and forged a face-saving agreement to normalize relations with Seoul. (Seoul, which has been diligently developing its own missile defense and anti-artillery systems to wean itself off US hardware anyway, conceded only vague promises to scale back its participation in the US ballistic missile defense network in East Asia.) China’s official position on THAAD has not changed, but Chinese tour groups have begun returning to South Korea. China’s hearty welcome of South Korean President Moon Jae-in’s state visit last week essentially confirmed the return to the status quo.

So why were Beijing’s pressure tactics so ineffective? History shows that full-throated, multilateral sanctions efforts generally achieve their desired outcomes but only when the targeted government has strategic reasons to comply. And the strategic stakes for the country pushing the sanctions must be high enough that it will risk heavy diplomatic and economic blowback. In the case of THAAD, neither of these dynamics was at play.

Beijing’s concerns about the THAAD deployment never really matched the intensity of its protestations. China has good reasons to be wary of US defense systems on its doorstep, but THAAD itself does not jeopardize China’s nuclear deterrence capabilities as claimed.

Beijing’s economic retaliation therefore never really rose to a level that would inflict real pain on the South Korean economy, which is still expected to grow at a brisk 3.2% clip this year. In fact, China was unwilling to push measures that would require any amount of economic sacrifice on its own part—barring South Korean investment in China or withdrawing from an important currency swap agreement, for example. Retaliation was limited to areas in which Chinese firms and consumers had ample alternatives. (Chinese tourists, for example, could just as easily vacation somewhere else.)

Even if Beijing had been willing to go further, it’s doubtful that the Chinese could have implemented economic measures strong enough to outweigh Seoul’s immediate security imperatives or longer-term strategic considerations—namely, North Korea. The South is squarely within range of the North’s full —and expanding—ballistic missile arsenal. There is still a possibility that the crisis on the Korean Peninsula ends in war.

The notion that Seoul would weaken its missile defense to boost the prospects of its tourism sector isn’t one to be taken seriously. Beijing presumably never expected that it would, and realized that in its posturing it was backing itself into a diplomatic corner that threatened its credibility in the region. Thus, as soon as Seoul called Beijing’s bluff on THAAD, the Chinese took the first chance to move on.

The THAAD measures, moreover, were at odds with China’s much more important strategic goals—to weaken the US position in Northeast Asia—at a time when circumstances were ripening for progress. At issue is the divergence in the US’s and South Korea’s preferred plan for managing the North Korean nuclear threat. The US is more willing to deal with it militarily. South Korea would rather live with a nuclear North Korea than be obliterated by North Korean artillery, as may happen if the US goes to war with the North.

We don’t think the US is going to attack the North; doing so could destroy its alliance with the South. But the possibility of war is real enough that China is eager to drive a deeper wedge between Seoul and Washington. If the US ultimately decides to live with a nuclear North Korea, as we increasingly suspect it will, the resultant deterrence strategy may well create other opportunities for China to drive the same wedge. Either way, it makes little sense for China to undermine the narrative it has crafted as it has risen to power—that it is more willing and able to protect the region than the United States is.

Admittedly, the THAAD disagreement doesn’t tell us everything we need to know about how effective China will be in economically coercing its neighbors. But what it does tell us shouldn’t be particularly encouraging for Chinese strategic planners.

It’s one thing for Beijing to use overwhelming aid and investment to effectively buy the loyalty of a weaker regional state—say, Cambodia—where the strategic stakes are comparatively low. It’s another to try to bully into submission a wealthy US ally that’s staring down the barrel of mass destruction across its northern border.