Think Again: China

It's often said that China is walking a tightrope: Its economy depends on foreign money, its leadership is set in its ways, and its military expansion threatens the world. But the Middle Kingdom's immediate dangers run deeper than you realize.

"China's Biggest Risks Are Economic"

"China’s Biggest Risks Are Economic"

No. In fact, China’s most severe risks are ecological — particularly its environmental problems and its vulnerability to communicable disease. Of course, this is not to say that China has no economic problems. No country is immune from the normal business cycle, and China today is subject to both inflationary and recessionary risks. But Beijing is developing the fiscal and monetary tools to regulate the economy so as to prevent these problems from becoming catastrophic once they emerge.

In contrast, China’s ecological and health risks are far more serious than people realize. Air pollution in China is affecting the quality of life in cities like Beijing, Hong Kong, and Shanghai, among others. The risk of water shortages, both in agricultural areas and major cities, is high and growing; only 1 percent of the surface water available to Shanghai is safe to drink. In one harbinger of things to come, an explosion at a chemical plant in northeast China in November 2005 sent a benzene slick cascading down the Songhua River. Millions of people in the large, industrial city of Harbin were without water for a week. The probability of more acute environmental crises resulting from chemical spills or toxic emissions is high. The Chinese government is already warning that the country’s emission of carbon dioxide and greenhouse gases will significantly damage China’s agricultural production.

China is also experiencing epidemics of chronic disease. Reported cases of HIV increased by 30 percent to roughly 650,000 in 2006, and the United Nations projects that 10 million Chinese will be infected by 2010. Hepatitis infects 10 percent of the country’s population. The probability of an outbreak of an acute communicable disease, such as the avian flu, remains high. The main issue is how virulent the virus will be, and whether its spread can be contained. The risk is exacerbated by the decay of the rural public health system due to lack of funding and by the reluctance of local officials to report new occurrences of the disease, making it more likely that an outbreak will become a deadly epidemic.

"A Second Tiananmen Crisis Is Inevitable"

Hardly. The Tiananmen Square crisis of 1989 involved mass protests in scores of cities across China — and the demonstrations in Beijing were so large that the government was able to suppress them only through the use of brutal military force. Though not inconceivable, another dramatic uprising on that scale is unlikely.

It is true, however, that China has many problems that are producing widespread popular discontent. These include environmental problems; gaps in the country’s social safety net, particularly with regard to health insurance and old-age pensions; controversies over land and water rights; and chronic corruption among officials. These grievances have caused a sharp increase in grassroots protests. The Chinese government itself reported some 80,000 such incidents in 2005, some of which were quite large and even violent. In the most notorious uprising, in late 2005, riot police fired at protesting farmers in a rural Guangdong Province village. Witnesses claim as many as 20 villagers were killed.

But Chinese leaders are adopting policies to address the causes of rural grievance, such as increasing spending on rural projects, abolishing onerous agricultural taxes, and cracking down on local officials who squeeze villagers. When protests do occur, they arrest the leaders but often try to remedy the particular issues that caused the unrest. Six months after the fatal confrontation in Guangdong, a similar protest nearby ended with official promises to review the terms of the land confiscation that had provoked it. Above all, by controlling the media and suppressing independent political organization, Beijing is trying to ensure that protests remain localized. Moreover, in many quarters, particularly China’s growing urban middle class, political support for the government appears to be quite high.

The real concern is whether bigger issues could foil these efforts. The emergence of serious and widespread economic problems (especially inflation and unemployment) or the government being blamed for a major domestic or international crisis (such as an environmental catastrophe or an incident during the upcoming 2008 Olympics) could lead to nationwide discontent. It would be particularly dangerous if the dissatisfaction were so widespread that it overwhelmed the party’s control over the media and the Internet, or produced a divided leadership unable to respond effectively. In such a circumstance, there could be large-scale protests in several major cities that might be difficult to control, as was the case in 1989.

"Chinese Elite Politics Are Stable"

Yes. but less than you might think. Chinese politics has become increasingly institutionalized, the elite are more pragmatic, and top leaders want to avoid a perception of internecine feuding. But President Hu Jintao has had to tread more softly than his predecessors. Although he has been able to secure the dismissals of a few central and provincial leaders by charging them with corruption, he has not yet been able to replace them with his own protégés.

Hu is nearing the end of his first five-year term. Past practice suggests that one or two potential successors should have been appointed to the Politburo by now. The president will have to identify his heirs apparent by the 17th Communist Party Congress this fall so they have enough time to win broader support before Hu retires in 2012. If his choices are not widely accepted, the result could be a decline in the party’s legitimacy. Indeed, the uncertainties surrounding succession now constitute the biggest political risk facing China this year.

What is even more worrying is that the gridlocked succession may reflect a lack of agreement on China’s policy decisions. True, Hu recently secured formal endorsement of his stance that China needs to address its most serious domestic problems and spread the benefits of economic growth in order to tamp down social conflict. But that doesn’t preclude a debate over how to achieve that goal. For one thing, the party has defined one of its primary goals as creating a "harmonious socialist society," which implies that any policy option that isn’t "socialist" — for example, protecting private property rights or moving toward pluralistic democracy — should be taken off the table. For another, although Hu talks about the need for sustainable development, the party leaders still assign priority to rapid economic growth. Those decisions give easy rhetorical openings to any of Hu’s rivals who may want to challenge his political agenda going forward.

"China’s Banks Will Collapse"

Doubtful. Until very recently, China’s banking system was in big trouble. It was the main mechanism for financing the country’s high levels of investment, which made up 45 percent of gross domestic product (GDP) in 2005. The banks faced considerable pressure to lend money to inefficient state-owned enterprises. As a result, the volume of the country’s nonperforming loans rose to alarming levels. But the banks survived, largely because depositors had few other outlets for their savings. The banking system was not that solvent, but it remained liquid.

In more recent years, though, China’s corporate sector has become a less risky customer for the banks. Investment is increasingly being financed by means other than bank loans, such as bond issues, corporate profits, or stock offerings. The latter have yielded record-breaking sums, with the Industrial and Commercial Bank of China leading the way with a $22 billion initial public offering last fall. And a gradual process of mergers, acquisitions, and privatization is increasing the profitability of formerly state-owned enterprises.

At the same time, the solvency of the banks has also improved. China has been recapitalizing banks, transferring nonperforming loans to management companies, and inviting partial foreign ownership of major banks. In addition, the banks’ portfolios are being broadened through greater reliance on home mortgages and fee-generating services.

China’s financial system isn’t entirely out of the woods. The banks’ lending decisions are still subject to political pressures because the party still chooses senior bank executives from its ranks. The health of smaller local banks, various investment brokerages, and insurance companies is not ideal. And with a growing range of investment opportunities — including the stock market, real estate, and even foreign mutual funds — Chinese banks now have to worry that financial insolvency could more easily generate liquidity problems.

Even so, China’s low level of foreign indebtedness gives the government the tools to contain the economic consequences of a financial crisis.

"China Is Too Dependent on Foreign Money"

Not really. China is certainly highly integrated into today’s international economy. By abandoning the economic autarchy of the Maoist period, it has become a major trading nation. It exports large volumes of textiles, machinery, and electronic equipment. In turn, it imports advanced technology, petroleum, and other natural resources. It is also a favored destination for foreign direct investment (FDI), not only because of its attractiveness as a manufacturing platform for exports, but because of the size and dynamism of its own domestic market. China now attracts twice the FDI it did 10 years ago.

The relatively large ratio of exports to China’s GDP and the volumes of incoming FDI have generated concern that China is too dependent on the international economy and is acutely vulnerable to a slowdown. But these concerns are overblown. For one thing, with $1 trillion in foreign exchange reserves, and an extraordinarily high domestic savings rate of roughly 47 percent, China is hardly dependent on foreign capital. It has relied on the technology and marketing networks that accompany foreign investment to promote its exports, but it would most likely survive a reduction in new investment fairly easily.

The same is true with trade. China is a large continental economy, and at 64 percent of GDP, its trade dependence is far lower than that of places such as Hong Kong or Singapore. Moreover, much of the value of Chinese exports is provided by imported components and raw materials, with local elements providing relatively less value. Computers bearing the tag "Made in China" may be assembled there, but their screens and microprocessors likely come from Taiwan or South Korea. Processing and assembly accounted for 55 percent of China’s total exports in 2006. That means that the net contribution of trade to the Chinese economy is less than the gross figures imply. Sure, China would take a hit if there were a severe global recession or a terrorist attack that crippled international trade flows. But its economy could weather that challenge far better than most.

"Chinese Nationalism Is on the Rise"

Yes, but don’t exaggerate its implications. Popular nationalism has been a part of China’s fabric since the middle of the 19th century. It emerged as a reaction to invasion by nations more technologically advanced than China — first from Europe, then Japan. More recently, the Chinese Communist Party, whose ideological appeal began to erode in the 1980s, has been encouraging nationalism as a source of legitimacy.

But the party recognizes that nationalism is a double-edged sword. Although it can be a source of domestic legitimacy, it can also generate apprehension and mistrust abroad. That lesson was borne out by several anti-foreign protests, including those against the United States for the accidental bombing of the Chinese Embassy in Belgrade in 1999 and for the collision between an American reconnaissance aircraft and a Chinese fighter in 2001. Although these episodes did no lasting damage to China’s relations with the United States, Beijing was alarmed by the fervor of the protests and the time it took to bring them to an end. China’s leaders understand that nationalism can generate public criticism of leaders who "capitulate" to foreign governments just as easily as it generates support for those who are perceived as upholding Chinese interests.

Accordingly, the promotion of nationalism now plays a smaller role in the party’s search for legitimacy. It has been replaced to a degree by the quest for a "harmonious socialist society." The media now repeatedly emphasize that China’s rise should be peaceful, and officials try to keep nationalist sentiment in check.

The problem is that popular nationalism can have its own momentum, independent of the wishes of the party’s leadership. But without further democratization, nationalistic public opinion isn’t powerful enough to determine Chinese foreign policy. At the margins, however, it reduces the flexibility of Chinese foreign policymakers. It could be a source of political instability if the Chinese government were accused of failing to uphold the national interest in the event of an international crisis.

"China’s Rise Will Lead to Military Conflict"

Highly Unlikely. at least for the foreseeable future. Yes, China is modernizing its military, seeking not only a stronger nuclear deterrent but also a greater ability to project conventional force. And like any powerful country, China will use force if it believes its vital national interests are at stake, particularly concerning the disputes over islands and undersea resources in the East China Sea and the South China Sea, the possible collapse of North Korea, and, above all, the possibility of a declaration of independence by Taiwan.

But China is no longer a revolutionary power. It does not have fundamental complaints about the international economic and political systems from which it has benefited so much over the past 25 years. Moreover, its economic interdependence with the rest of the world will deter Beijing from military adventures unless such core interests are threatened. The rise of Chinese power, in turn, will deter China’s neighbors from threatening its core interests. Beijing has drawn its red line in the Taiwan Strait so narrowly — a de jure declaration of independence by Taiwan — that it is unlikely ever to be crossed.

The real challenges from China are, therefore, far more subtle than alarmists would suggest. First, though China is willing to join the existing international order, it wants to play a larger role — as a rule-maker, not just a rule-taker. Fortunately, Washington’s current policy of encouraging China to become a "responsible stakeholder" in the international system is largely compatible with Beijing’s desire for greater influence.

A second challenge stems from the desire that Chinese firms gain the greatest market share domestically and join the ranks of large, profitable multinationals. China is a poster child for globalization, but Beijing’s objective is to see that Chinese firms, and not foreign firms, are the winners of that global competition. Indeed, economic nationalism may pose a greater challenge for the world than any other form of Chinese power.

China is simultaneously rising on several dimensions — military, economic, diplomatic, ideological, and cultural. In that regard, it more closely resembles the United States of the 1950s than, say, 1930s Japan or Stalinist Russia. The greatest risk is not that Beijing will use its military power to attack other countries, but rather that it will use its growing resources to shift the overall balance of power in China’s favor, especially in Asia. It is a strategic shift that has already begun.

Harry Harding is counselor and chair of the China Task Force at the Eurasia Group, a political risk research firm based in New York. He is also university professor of international affairs at George Washington University.

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