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Net Assessment of East Asia

May 12, 2016 The economic downturn in China will have significant consequences for the whole region.

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Summary Since Geopolitical Futures launched on Dec. 2, East Asia has been one of the most active regions in the world. The basic building blocks of our Net Assessment of the region, which we published in December, still hold, but the model advanced significantly at the beginning of 2016, as China experienced two crashes in its stock market. Stock markets in China are not very important in themselves, but these crashes severely undermined foreign confidence in China’s ability to implement economic policy and led to speculation on the yuan and accelerated reorganization at the top of China’s political structureChina now lives in a “new normal,” and what was an economic problem has become a serious political problem as well.

East Asia can be divided into four distinct parts. The first is the Pacific archipelago, which most notably includes Japan but also the Philippines and Taiwan. The second part extends from the Chinese coast 400 miles inward, reaching western China, a vast and sparsely populated desert region. These 400 miles are the Chinese agricultural heartland, centered around the Yellow River in the north and the Yangtze River in the south. China’s core is surrounded by three non-ethnically Chinese regions governed by the Chinese government and functioning as buffer states: Tibet, Xinjiang and Inner Mongolia. The third part of East Asia is the Korean Peninsula, jutting out from the mainland and wedged precariously between China and Japan. To the south and southwest of China is the last area of the region, Indochina – the lands between India and China – including Myanmar, Thailand, Laos, Cambodia, Vietnam and the Malay Peninsula. These latter parts of East Asia are essentially China’s periphery.

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Though the United States is located in the Western Hemisphere, an argument could be made that it is essentially part of East Asia in its own right because the U.S. is as much a Pacific power as it is an Atlantic power. Japan and the United States went to war in 1941 precisely because the U.S. felt threatened by Japanese maritime power and sought to limit Japan’s access to the resources needed to power the American industrialized economy. The U.S. patrols the world’s oceans and, therefore, is deeply invested in East Asia’s geopolitics.

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East Asia is the world’s most dynamic economic region. Since the early 1980s, annual trans-Pacific trade has outpaced trans-Atlantic trade. China and Japan are the second and third largest economies in the world. The Strait of Malacca, located at the tip of the Malay Peninsula, has become the world’s busiest trade route, with roughly two-thirds of the world’s oil and a third of the world’s bulk cargo transiting to and from the Indian and Pacific oceans. Much of the bulk cargo is made up of Chinese, Japanese and South Korean imports of hydrocarbons and raw materials from the Middle East and Africa. Myanmar, Laos, Vietnam, Cambodia, Indonesia and the Philippines are all up-and-coming countries poised to take advantage of Japan’s demographic woes and China’s attempt at economic transformation in order to join a new generation of low-wage, high-growth, export-driven economies.

The center of gravity in East Asia is the relationship between the two countries with the region’s largest economies and strongest militaries – China and Japan – and their individual and collective relationships with the United States. The key to this relationship is China’s internal economic and domestic political situation. When China is unified and strong, as it is at the moment, its influence in the Asian mainland is pervasive, with the peripheral states in southeast Asia looking to Japan and the United States for balance. When China goes through a fragmentary phase, as it did from the mid-19th century until the communists took power in 1949, the peripheral states can at times assert themselves. China then becomes susceptible to foreign control or even invasion, as when the Japanese invaded and occupied large parts of eastern China and Manchuria in the 1930s. The Koreas are less critical to the region at the moment, but their location between these two powers makes them significant to this dynamic as well.

History of Instability

Despite some saber-rattling in the South China Sea, East Asia’s challenges in recent years have had more to do with economics than with aggression. But it is important to keep in mind that the last 30 or so years in Asia have been something of an aberration. For most of the 20th century, East Asia was rife with instability and war. The United States fought wars in Korea and Vietnam as part of its containment strategy during the Cold War. China fought a civil war, which resulted in Mao and the Communist Party taking over the country and closing it off from the world until Deng Xiaoping opened the economy in 1979. Vietnam deposed the pro-Chinese Khmer Rouge from Cambodia and fought an indecisive war with China over it. China and India squared off in small skirmishes twice. Japan began the century by defeating the Russians in battle and followed this by conquering large swaths of China and attempting to knock the United States out of the western Pacific. Therefore, beneath the region’s recent economic prosperity and stability, there is a deep reservoir of conflict.

Of all these conflicts, World War II was the defining one because it shaped the way the economies of East Asia would develop. One of the key differences between Japan and China is that Japan possesses none of the raw materials necessary to sustain its industrial economy.  Japan is, therefore, extremely dependent on imports of raw materials and when the status of Indochina and what is today known as Indonesia became uncertain, Japan wanted to secure these routes – which meant taking the Philippines, an American protectorate. This was what led Japan to attack the United States at Pearl Harbor in 1941.

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Japan’s defeat in World War II devastated the Japanese economy. But the United States had a vested interest in helping the Japanese rediscover some of its economic power because the U.S. was in need of a capitalist ally in the region. The Korean War made the relationship even more important to the United States, as the U.S. required a way to supply its soldiers fighting in Korea. Furthermore, Japan maintained its social cohesion after its defeat and the United States did not follow through with breaking up Japan’s traditional economic classes and oligarchs because it needed Japan to recover.

The result was that, by 1990, Japan had built the world’s second largest economy by focusing on low-cost manufacturing. In the 19th century, the United States was the low-wage, high-growth region upon which a global capitalist system depended and, after World War II, Japan took over. Japan’s dependence on export-driven growth, however, is what led to its own economic crisis between 1989 and 1991 and the intervening decades of volatility and low growth. As the standard of living grew, Japan had to borrow more and more capital to maintain employment rates. As China, South Korea and other countries began to compete with Japan for exports, Japan was forced to cut prices, further reducing profits. Taiwan and South Korea faced a similar crisis in 1997.

China’s Economic Ups and Downs

China was the heir to Japan’s role in the global economic system. Before World War II, China was fragmented and in a state of civil war. In the past, when China’s economy was opened up to the world, as it was after the Opium Wars with Great Britain in the 19th century, wealth in China’s coastal regions increased and its poor interior regions remained poor. Japan took advantage of China’s internal fractiousness in the 1930s, and, with the U.S. victory in World War II, there was concern that the U.S. would also assert itself in China. Therefore, when Mao came to power, he sacrificed prosperity in China’s coastal regions for social stability. Mao shut China off from most international trade and used the ideology of the Communist Party to suppress dissent and ensure stability and unity.

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After Mao died, China’s leaders decided that the country’s economic weakness was too big of a risk. Thirty years of preternatural growth rates began and, once again, the coastal regions became prosperous. Cities like Shanghai became incredibly wealthy. For a generation, China was the world’s largest low-wage, high-growth country, and today it is the world’s second largest economy. But 2008 was an inflection point for China. The global financial crisis hit exporting economies particularly hard. China committed itself to maintaining high growth rates in order to protect employment rates and social stability, while sacrificing profitability. Suddenly, companies with operations in China began to move to different countries with relatively lower wages.

Another inflection point in this process has developed in 2016: it marks the year that the rest of the world figured out the Chinese bubble had finally burst. The events set in motion by 2008 have come home to roost in a global economic crisis for all exporting countries. It has also resulted in a large decrease in the price of commodities – even with China still buying large amounts of steel and iron despite an oversupplied market.

China is now trying to pull off what Japan has – a transition to a more stable economic situation without setting off crippling social unrest. This has not been easy for Japan. The last 20 years for the country are often referred to as the lost decades and have been very messy economically at times. But Japan has been able to weather this storm because it has a much higher degree of informal social control than China and is a more homogenous society.

This transition will be more difficult for China. For one thing, the country has a much larger and poorer population than Japan. Furthermore, China does not have the kind of social cohesiveness that binds Japanese society together. China has become a wealthier country over the past 30 years, but inequality has also increased.

A recession in China does not simply mean a time of economic hardship – it means the relationship between China’s massive population and its central government could be called into question. This reverberates not only in the general population but also in the vast national and regional bureaucracy that rules China, as well as the military-security apparatus that enforces the will of the Communist Party. Party officials have been enriched by the economic status quo, which will make any government attempts at re-establishing central control difficult. Indeed, 2015 saw increasing levels of unrest compared to previous years.

Chinese President Xi Jinping responded by attempting to reassert the party’s control over Beijing’s ruling structure. Xi has embarked on what he is calling a massive anti-corruption campaign, which has resulted in hundreds of thousands of government officials being investigated and charged with corruption. The campaign is wide-ranging and has affected everything from government bureaucracies to the military and police forces. The targets have not been limited to low to mid-level officials – former members of the Politburo Standing Committee (the top leadership of the Communist Party), as well as generals who served on the Central Military Commission, have all come under investigation. Make no mistake: these anti-corruption crusades are purges of the party, as Xi attempts to respond to China’s domestic challenges and positions himself for the important 19th Party Congress in 2017.

In recent months, Xi has increasingly centralized economic decision-making either in his own authority or in small committees and councils whose members he has chosen. He has also reorganized the People’s Liberation Army (PLA), set up an anti-corruption investigation committee within the PLA and focused on eliminating his rivals at the top of the government. It is important to remember that China spent more on internal security than on its defense budget in 2011, despite the attention its actions in the South China Sea has garnered.

America’s Role

U.S. strategy in East Asia is two-fold. On one hand, the U.S. seeks to maintain a balance of power between Japan and China. On the other hand, the U.S. employs a maritime strategy whereby it cultivates close relationships with island nations in the western Pacific to maintain its control over trade routes and contain the Chinese on the mainland.

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Much is made of Chinese moves in the South China Sea, but the truth is that such moves are more for domestic political consumption than anything else. China faces many constraints on its ability to project military power abroad. The Chinese navy can make noise in the South China Sea and the East China Sea, but it is still no match for the U.S. Navy. Optimistic projections suggest that, by 2020, China could theoretically field a navy only one-fifth the size of the U.S., in terms of its number of aircraft carriers, Aegis-like destroyers and nuclear attack submarines. And even if such projections are realistic, they in no way take into account the fact that China has not been a naval power for centuries and building a navy is as much about having well-trained and experienced sailors as it is about building ships. Developing this human capital is something that takes decades, if not generations. The figures also do not say anything about the qualitative difference between U.S. and Chinese equipment.

China has neither the ability nor the appetite for military conflict with the U.S., even though the U.S. is already re-establishing relationships with countries along China’s periphery, including Japan, Taiwan, the Philippines and Indonesia. Whether it is jungle, mountains or desert, China’s terrain also limits its ability to project land-based power in its own neighborhood. Japan has more of an imperative than China to act aggressively in East Asia because it is so heavily dependent on the import of raw materials. Although China also imports large quantities of raw materials, it has plenty of its own. Meanwhile, Japan is dependent on maritime trade routes remaining secure and open. Japan currently relies on the United States to keep these routes accessible and this will not change in the near future. Therefore, one of the country’s key strategic imperatives is not in its own hands, but rather in the hands of the United States. That is an unsettling reality for Tokyo, and one it never forgets.

North Korea is another widely discussed issue in East Asia, but ultimately the country is more of a sideshow than a main attraction. The U.S. maintains a military presence in South Korea; the rationale behind the deployment initially was to instill confidence in U.S. allies in the region during the Cold War. Therefore, having military forces on the ground in South Korea does not fit squarely into the U.S. maritime strategy. Furthermore, for all of its bluster, North Korea’s actions have never necessitated a direct military response from South Korea, the U.S. or any other major power. Pyongyang uses the nuclear threat to legitimize its regime and to secure diplomatic concessions. The U.S. relationship with South Korea is useful and will become increasingly important for maintaining a balance of power as Japan strengthens, but the current dynamic is dictated more by inertia than anything else.

For now, the United States has too many distractions to make East Asia a top priority – the rise of the Islamic State in the Middle East and Russia’s moves against its European neighbors are monopolizing Washington’s attention. Neither Japan nor China is strong enough to be the de facto regional hegemon and it is in neither’s interest to challenge U.S. dominance. While Japan and China compete with each other in myriad ways, both right now are in different phases of dealing with internal economic issues. The U.S. is currently managing its relationships with both countries – having a stable China is in the interest of the United States and maintaining trust in its relationship with the Japanese is also crucial. In the meantime, the U.S. continues to strengthen its relationships with countries on China’s periphery.

In addition, the Sino-Japanese balance of power is relatively stable, with both countries prioritizing their relationship with the United States over competition with the other. But both are in the introductory phases of processes that will profoundly change them. Japan faces a serious demographic crisis – its elderly population is increasing as its working-age population is falling – and it must either enact austerity measures or increase debt to even higher levels to maintain full employment. It is also beginning to confront its past and change the way it thinks about military engagement abroad.

However, the key to East Asia right now is China’s domestic evolution. China is at the beginning of a long and painful attempt to try and redistribute the wealth of its coastal regions to the interior without damaging the country’s unity and cohesiveness. This has already changed the way the Chinese government behaves internally and also shapes China’s interaction with the rest of the world. Japan, South Korea and China’s peripheral states are all affected by the direction China takes. The United States’ relationship with other East Asian countries will also be shaped by China’s future. In a system that is mostly stable right now, China remains a question mark, and its ability (or lack thereof) to transform its economy – or else deal with internal fragmentation and social unrest due to economic weakness and political repression – affects the entire region.