SUPERPOWER STATUS

by Yolanda Fernández Lommen  and Plamen Tonchev

First published in the Institute of International Economic Relations, September 1998.
HTML version prepared by Dr. Robinson Rojas

About the authors:

Ms. Yolanda Fernández Lommen, an economist by education, has specialised in Asian Economies with a particular emphasis on China. She holds a MA degree in Economic Theory from the Autonoma University of Madrid, Spain, a MA degree in International Affairs from the University Institute José Ortega y Gasset of Madrid, and has completed the Advanced Studies Program for Economic Policy Research from the World Institute of Internationals Economics of Kiel, Germany.

Since 1992, Ms. Yolanda Fernández Lommen has worked as a Research Fellow in the Royal Spanish Centre of International Relations (CERI) in Madrid, and is currently the head of the Asian Studies Unit. Furthermore, Ms. Fernández Lommen is involved in university teaching activities as an associate professor of Applied Economics at the Economic Structure and Industrial Economics department of the Complutense University in Madrid.

Among her various publications, one should mention two books on the Chinese economy transformation, published in Spanish and entitled: China’s Economy Towards the 21st Century. 20 Years of Reform (published by Sintesis Publications in May 1996), and "Spain in the Chinese Economic Reform", (sponsored by the Spanish Ministry of Foreign Affairs and published by Planeta Editions in October 1996).

Mr. Plamen Tonchev, a political and economic analyst, has specialised in international affairs, and holds a MA degree in European Institutions and Diplomacy from the University of Athens, Greece. Currently, he is a Ph.D. candidate at the University of Athens and the National Technical University of Athens. His Ph.D. thesis is being supported by the Sasakawa Foundation, Japan.

Mr. Tonchev has worked as a correspondent and a reporter as well as an international relations advisor to the European Commission and the European Parliament. Until recently, he was the Coordinator of the Centre for Japanese and Asian Studies of the Hellenic Foundation for European and Foreign Policy (ELIAMEP).

Mr. Tonchev’s academic interests lie in the area of political science and socio-economic development, at the interface of politics and economy. He is particularly concerned with Asian affairs, with stress increasingly being laid on energy politics. His latest publications include "Rising Asian Oil Demand and Caspian Reserves" (Caspian Crossroads Journal, 1998, No. 2), "Security Aspects of EU Oil Dependence and the Caspian Sea Case" (Research Institute for International and European Studies, Athens, 1998), and "China and Iran: A New Tandem in World Energy Security?" (Centro Espanol de Relaciones Internacionales (CERI), Madrid, 1998).

CONTENTS

Abbreviations and Acronyms                                                             

List of Tables and Figures                                                                   

1. Introduction                                                                                   

2.       The Economic and Political Context of the Wider Area          
2.1.    Main Features of the Region                                                
2.2.    The "East Asian Miracle"                                                    
2.3.    Patterns of the "Miracle"                                                      
2.3.1. The Japanese Pattern                                                        
2.3.2. The "Flying Geese" Model                                               
2.3.3. Other Patterns in the Region                                            
2.4.   The Dark Side of the Miracle                                            

3. China from Within                                                                  
3.1. A Closer Look at Post-War China
3.2. China’s Economy and the Role of Foreign Direct Investment  
3.3. Challenges for China at the Turn of the Century                        
3.3.1. Regional Disparities                                                              
3.3.2. The Management of State Owned-Enterprises (SOEs)          
3.3.3. Rising Unemployment                                                             
3.3.4. Insufficient Fiscal Reform                                                      
3.3.5. Increasing Energy Demand                                                    

4. China’s Presence in East and Southeast Asia                              
4. 1. China Proper and Greater China                                              
4.1.1. The Chinese Diaspora                                                            
4.1.2. The Economic Weight of Overseas Chinese                          
4. 2. The security Puzzle in East Asia                                              
4.2.1. China’s Security Priorities in the Region                              
4.2.2. China and the US: Towards a Special Relationship               

5. China’s Future Prospects in the Region                                        
5.1. China in the Post-Cold War World                                          
5.2. An Emerging Regional Superpower?                                        
5.3. Could China Prove the "Saviour" of the Region?                      
5.3.1. The Renminbi Issue                                                                
5.3.2. China’s Export Engine                                                            
5.3.3. China’s Role In Containing the Crisis                                    

6. Conclusions                                                                                  
    References                                                                                    

ABBREVIATIONS AND ACRONYMS :
APEC - Asia Pacific Economic Cooperation
ARF - ASEAN Regional Forum
ASEAN - Association of Southeast Asian Nations
CCP - Chinese Communist Party
EAEC - East Asian Economic Caucus
FDI - Foreign Direct Investment
GATT - General Agreement on Trade and Tariffs
GDP - Gross Domestic Product
GNP - Gross National Product
HKSAR - Hong Kong Special Administrative Region
HPAEs - High Performing Asian Economies
IED - Inter-enterprise debt
IMF - International Monetary Fund
MSDF - Maritime Self-Defense Force
OECD - Organisation of Economic Cooperation and Development
PLA - People’s Liberation Army
PRC - People’s Republic of China
ROC - Republic of China
RMB - Renminbi
SEZs - Special Economic Zones
SOEs - State-owned enterprises
US - United States of America
WTO - World Trade Organization

LIST OF TABLES AND FIGURES

TABLES
Table 1.: China Foreign Direct Investment                                                  
Table 2.: Major Indicators of the Chinese Economy, 1997                          
Table 3.: China’s and Japan’s Economic Impact Outside Their Borders      

FIGURES
Figure 1.: Average Growth of GNP per Capita 1966-1990                          
Figure 2.: The World’s Largest Economies 1995-2020                                
Figure 3.: The Composition of Chinese exports, 1997                                  
Figure 4.: Chinese Exports by Destination, 1997                                          

1. Introduction

This paper is the outcome of a joint effort undertaken by two researchers of quite different backgrounds. Ms. Yolanda Fernandez Lommen is an economist specialising in Chinese studies, whereas Mr. Plamen Tonchev is a political scientist working on East Asia. The idea of this publication came up in May 1998 in Baden-bei-Wien, Austria, during a very stimulating international meeting attended by both Europeans and Asians in the context of ASEM activities following on the 1996 Bangkok summit.

This paper draws on the findings of previous research carried out by the authors. For instance, earlier this year, Plamen Tonchev published an article on "China’s Looming Presence in East Asia" in the International Relations Forum journal of the Association of International Relations Students at the University of Athens. Yolanda Fernandez Lommen, on her part, published a paper on China’s integration in the international community ("La inserción de China en la Comunidad Internacional") in the Papeles de Cuestiones Internacionales, Centro de Investigaciones por la Paz, Madrid, also in 1998.

The paper was drawn nearly a year after the outbreak of the worst post-war financial crisis in Southeast Asia, amidst tremendous confusion and uncertainty. Indonesia has seen its leader Suharto resign, Japan has got a new Prime Minister and many more changes may well be in store in the region. The implications of the turmoil are yet to be fully explored and assessed, and it would be a high-risk task to predict exactly what might follow in the near future.

However, it was deemed that China’s relation to the current crisis in Southeast Asia, one that took many governments by surprise, called for a more profound research on the cause-and-effect processes that have been taking place over a considerable span of time.

Thus, the paper aspires to looking into the way China emerged from its decade-long isolation and turned into a major power in the region of East Asia. What is more, this huge and amazing country is avowedly heading to an even greater role, no doubt of international importance.

Some of the questions posed in the paper would be: What major changes took place in China’s domestic politics and economy during Deng’s rule and after his death? What new role will China claim both in East Asia and on a global scale into the 21st century? What challenges does China have to face on its way to a superpower status?

The scope of issues is so enormous, that only self-restraint could have ensured a reasonable length of the paper and, hopefully, a focus on the questions posed. Luckily, Chinese studies are virtually mushrooming and the present study is intended to constitute a small contribution to available literature on this fascinating country.

September 1998

2. The economic and political context of the wider area

2.1. Main Features of the Region

The region of East and Southeast Asia, regarded here as East Asia for reasons of brevity, constitutes one of the most turbulent areas worldwide. It has been plagued by severe military clashes, an enormous charge of conflicting interests, rapid social and economic developments, remarkable dynamism in industrial output and trade exchange, and even sweeping natural disasters.

History is clearly a protagonist in the region, in the sense that tension accumulated through the centuries leads to suspicion and charges co-operation efforts with negative sentiments. On the other hand, the mere magnitude of the area and most of the countries increases the challenges to be faced. It should be noted that China is the largest country in the world in terms of population, with Indonesia ranking as the fourth most populous nation on a global scale. Japan is the second largest national economy and the region, as a whole, could be seen as the modern "world’s workshop", just as Britain was viewed in the 18th century.

However, what is conspicuous in the region is the considerable lack of well-established regional institutions which would enhance the sense of stability and security. Thus, ASEAN, the ASEAN Regional Forum (ARF), APEC, the Council for Secuirity Co-operation in the Asia-Pacific and the East Asian Economic Caucus (EAEC) would be the only structures in the area functioning to a varying degree.

Therefore, the lack of sufficient institutionalization is one of the most remarkable traits of East Asia and a source of uncertainty per se. It is within this framework - or, rather, absence of a well developed framework - that China is gaining assuming regional and worldwide importance.

2.2. The "East Asian Miracle"

The end of the Cold War by 1990 has strengthened the role of East Asia as an increasingly integrated regional pole. Yet, the origins of this trend can be found back in the 1950s in the emergence of Japan as a promising developing economy, enhanced by the strategy adopted by the US towards the region, characterized by two main aims: communism’s containment and the encouragement of capitalist economic order in Asia.

Within this context, the so-called East Asian Miracle arose, as the expression stood for the spectacular economic performance achieved by several east Asian countries since the early 1960s. In fact, the miraculous nature of this phenomenon that surprised the world lies in the incapability of the traditional development models to explain the rapid catching-up process of these Asian economies. Starting from an economy based on low per capita income, low labour productivity, low capital endowment, and low rates of investment, southeast Asian economies seemed to be caught in a poverty trap by the late 1950s.

However, in the early 1960s, the outward-looking strategy adopted in an economic environment characterized in most cases by strong government intervention, helped rapidly transform the region’s stagnant economies into high-growth export-driven ones, achieving outstanding growth rates, improving per capita income distribution, and reducing poverty to a certain extent.

Some researchers hold that "the East Asian Miracle has emerged as a major and flexible concept, embedded in wider discourses on capitalist development and industrialization which homogenize and seek to manage a changing ‘national’, regional and international political and economic order". Concerning the origin of the miracle, core explanations for East Asian dynamism,

"...continue to flow from liberal Anglo-American discourses which represent the dramatic industrialization of the region as a vindication of a free-trade model of capitalist development. A less influential, but still significant, set of Anglo-American approaches views the East Asian Miracle as a sort of lesson in neo-Keynesian economics. At the same time, a growing number of North American, West European and Australian observers attribute the rise of East Asia primarily to Confucianism or other perceived cultural/racial characteristics. Linked to these approaches are more explicitly racial discourses, which regard the rise of the ‘East’, especially Japan (and now China), as a threat to the ‘West’...".

What is certain, however, is that the impressive results surpassed any previous experience in history and located this group of East Asian countries among the top dynamic economies in the world (see Figure 1).

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FIGURE 1:

• AVERAGE GROWTH OF GNP PER CAPITA (%), 1965-1990

NOTE: The "High Performing Asian Economies" (HPAEs) are Japan, South Korea, Malaysia, Indonesia, Taiwan, China, Hong Kong and Singapore.

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2.3. Patterns of the "Miracle"

      2.3.1. The Japanese Pattern

Japan was the first Asian economy to achieve high growth standards. After World War Two, the Japanese government implemented a particular model of economic development that made the country, over a short period of time, one of the most promising economies in the world. Despite all the alarming warnings made up by the orthodox defending economists, this model performed surprisingly well. The combination of state direction, active industrial policy and export driven growth provided a miraculous recipe for Japan’s economy, which was heavily depressed in the wake of the military defeat.

Within this framework, the state intervened to promote exports and limit imports by a selective industrial policy targeting certain industries for development and offering them fiscal and economic incentives, but without distorting the market mechanism. At that time, the Japanese model became a model to emulate, as illustrated by the fact that South Korea and Taiwan quickly followed suit.

By comparison, the northeast Asian experience was already in progress, when other developing countries, mainly in South America, implemented an inward-looking development strategy adopting strong protectionism measures and minimizing international trade links. This model was clearly influenced by the Dependence theory, which would defy some of the main postulates of economic orthodoxy.

Meanwhile, northeast Asian governments offered specific incentives to manufacturers to expand export-oriented production for the sake of the international competitiveness. Thus, the outstanding growth rates, the improvement of per capita income, poverty reduction and the international upgrading of northeast Asian economies were the best arguments to support government intervention (instead of true laissez-faire) as a major factor in the economic take-off. Governments ensured that economic fundamentals were right, especially in maintaining a high rate of domestic savings for investment purposes. Thus, between 1960 and 1985, northeast Asian economies increases their real per capita income more than four times.

 2.3.2. The "Flying Geese" Model

Foreign exchange policy also became an important explaining factor of the rapid Asian economic development. In the 1980s the Japanese yen vis-á-vis the US dollar depreciated till the point of seriously increasing the bilateral trade deficit at the expense of the American side. The Japanese government was persuaded to revaluate the yen, a measure that inevitably damaged the superior Japanese competitiveness. In order to compensate its industry, Tokyo focused the core of its new economic policy within the region, encouraging national entrepreneurs to invest in the less developed Asian neighbours in a look-out for lower labour costs that could allow for productivity gains.

In fact, this policy shift benefited not only Japan, but the economies in which Japanese industrial processes were being de-localized. Thus, southeast Asian economies freely took advantage of the Japanese technological and managerial upwardness, to further develop and update their economic structures. This economic linkage, of which the authors of this paper present a very brief description, has resulted in a model of regional development known as "the flying geese", Japan being the "lead goose".

As a result of this model, the production process in Asia has become increasingly internationalized with key capital goods coming from Japan; labour-intensive assembly being performed in low-wage countries, such as China, Indonesia, Thailand, and even Vietnam; and more sophisticated operations, such as design, marketing and finance, being provided from Hong Kong, Singapore and Taiwan. Moreover, the Japanese FDI influx to the neighbouring countries helped to create a greater degree of regional economic integration. Some years later, South Korea and Taiwan, high performance economies based on the Japanese model, started also to direct their FDI to the region supporting the economic take-off in southeast Asia and in mainland China.

2.3.3. Other Patterns in the Region

The Japanese post-war miraculous model was also adopted by some of its southeast Asian neighbors. The introduction of some of the Japanese model’s features also performed well and induced rapid economic growth through the export-driven strategy and the advantages of integration into the international channels.

However, the southeast Asian model had its own characteristics and differed from the Japanese model in the degree of openness to foreign investment and multinational corporations. While northeast Asian economies (Japan, Taiwan and South Korea) emphasized local capital to finance the industrialization process, southeast Asian economies adopted a more open and liberal foreign capital regulation. Hence, the international capital influx was a crucial factor to the rapid growth in Indonesia, Malaysia and Thailand.

By contrast, the People’s Republic of China (PRC), after so many years of deep self-isolation from the global economy, implemented the "open-door policy" only in the early 1980s to pursue high and rapid growth though export-driven strategies and the valuable help of the increasing foreign direct investment (FDI) flying to the most promising emerging market in the world. The Chinese development experience will be presented in more detail in Chapter 3.

2.4. The Dark Side of the Miracle

This outstanding economic performance of many East Asian countries has been abruptly stopped by the most harmful financial turmoil the region is suffering ever since World War Two. Since the Thai currency showed clear signals of fundamental disequilibria in July 1997, and abandoned its pegged exchange rate system, the crisis has spilled over and seriously affected Indonesia, South Korea, Malaysia and the Philippines. By the end of 1997, the currencies of the affected countries depreciated sharply, expanding the negative impact to other currencies perceived by the market to be also vulnerable - and not just in Asia.

Initially, the Asian crisis was not expected to have a significant impact on the world economy. However, since South Korea, OECD economic partner and the world’s 11th largest economy was affected, the international spillover effects of the crisis became obvious. Exports to the affected countries account for 2.8% of Australia’s GDP, 1.7% of Japan’s, 0.7% of the United States’, and 0.6% of Europe’s. Economic forecasts indicate that the total direct impact of the crisis will be reduction in the real GDP of OECD countries by around 0.6%.

The financial crisis also reflected on the principal asset markets. Together with exchange rate declines, the fall in asset values adversely affected the banking system and the non-bank financial institutions. The financial crisis spread rapidly during the second half of 1997 and many other Asian developing economies were affected, too. With the exception of the People’s Republic of China and Hong Kong, the currencies of most other Asian economies depreciated, real estate values and stock markets fell sharply and financial sectors came under severe pressure.

As a result, many Asian economies experienced drastic slowdowns in terms of economic growth. GDP growth in the affected economies shrank in 1997, but the most negative impact of the crisis will be registered by the end of 1998, when most of the economies, such as Indonesia, Korea and Thailand, are expected to reach negative growth rates. Significant reductions (but not necessarily negative rates) are expected in Malaysia and the Philippines as well. In turn, China, Hong Kong and Taiwan, which have so far faced the crisis fairly well, will most probably register declining growth rates as far as southeast Asia witnesses a diminishing regional demand.

Moreover, the loss of confidence by foreign investors, who have started shifting their investments, has produced a severe decline in private capital inflows to the affected countries. According to recent estimates, the affected Asian countries suffered net private capital outflows of $12 billion in 1997, compared to net inflows of $93 billion in 1996.

After the financial turmoil, that took everybody by surprise, the "East Asian Miracle" seems to be in trouble. Nevertheless, a modest recovery is expected in the affected area in 1999, but recovery to pre-crisis GDP growth rates and per capita income levels are difficult to be registered again. In addition, it must be kept in mind that the situation could deteriorate sharply, if the currency crisis and stock market crisis expand to China and Hong Kong. A Chinese economy under pressure will be faced with the need of currency devaluation approaching then an increasing risk of an internal economic slowdown threatening not only the region’s stability, but the international economic community as a whole.

3. China From Within

3.1. A Closer Look at Post-War China

China emerged from World War Two as an extremely underdeveloped nation which had to face its major economic and social backwardness in a near-isolation. For some two decades, the USSR was the only powerful friend and source of know-how for Beijing in a world engaged in the Cold War.

It is only natural then that post-war China started out as a communist state loyal to the Soviet Union and the main postulates of Marxism. However, a split between Moscow and Beijing in the 1960s was followed by the Maoist ten-year "Cultural Revolution", marked by a large-scale political witch hunt in the country and international isolation abroad. Mao Zedong died in 1976, and was succeeded by Deng Xiaoping within two years. The new leadership ushered in a series of significant changes, mostly in economic terms rather than in domestic politics.

Deng’s death in February 1997 was seen as the end of an era, but that may well be an overstatement. For instance, the four market tools introduced by Deng Xiaoping in economic management remain more or less in place: i) free prices, ii) the profit motive, iii) increased competition and iv) openness to the outside world. Not only do these tools remain enshrined in the underlying concept of Jiang Zemin’s leadership, but they also constitute pivotal notions for China on the eve of the year 2000 and into the 21st century.

Neither can a spectacular change be seen in China’s domestic politics and foreign policy. Deng denied the notion that prosperity might encourage other aspirations in China’s citizens - greater individual freedom, more accountability of the government, or anything that might be considered a necessary ingredient of a civil society. In a similar way, Jiang Zemin has so far behaved as a loyal leader of the Chinese Communist Party (CPP), which boasts 57 million members, or about 5% of the population.

China is in many ways a more stable place now, but a power struggle may yet ensue. Jiang Zemin, who is primus inter pares in China’s collective leadership, derives most of his legitimacy from Deng Xiaoping’s personal blessing, and the power of that blessing can be expected to wane as Deng’s specter recedes.

China’s post-war foreign policy has seen a number of changes, tension and cold-war opposition being the only common denominator for several decades. The former USSR and China split bitterly in the early 1960s; subsequently, clashes broke out along their common frontier. India and China fought a brief war along their Himalayan border in 1962. At times, Beijing took side in all the regional conflicts - Vietnam, Laos and Cambodia. The Sino-American relations were quite tense between 1949 (when Mao Zedong came to power) to 1972 (when Richard Nixon visited China).

Since then, China and the US have developed an uneasy, but ever closer, relationship, nearly severed on account of the 1989 Tiananmen events. For all that, it is clear that Washington and Beijing should be looked upon as two major powers fully engaged in the post-cold-war patchwork of international relations. Beijing’s rapprochement with Russia, Japan and multilateral global bodies is also worth mentioning.

By and large, the China of Deng Xiaoping and his successors appears to be much better adapted to the challenges of the post-cold-war era than it used to be in the 1980s. However, the amount of threats, both external and internal, for China remains considerable, and Beijing is bound to prove that its long-term strategy is really well-suited to the hazards inherent in East Asia.

The frustration that erupted in 1989 and culminated at Tiananmen Square was partly reactive - against economic disadvantage, party privilege and corruption. But it was also an explicit call for new things: freedom, equity and government accountability. Nine years later, none of these problems seems to have been efficiently tackled.

3.2. China’s Economy and the Role of Foreign Direct Investment

Although some of China’s structural problems have been considerably downplayed, the excitement about its record of economic growth, which averaged 9.3% between 1980 and 1995, is quite justified. Small wonder then that, according to recent World Bank reports, China may well be the largest economy in the world by 2020, with US and Japan coming second and third, respectively (see Figure 2).

-----------------------------------------

FIGURE 2:

ESTIMATES OF THE WORLD LARGEST ECONOMIES,

1995-2020 (in $ billion)

------------------------------------------

More specifically, the World Bank has found that, although China’s GDP per capita in 1990 was $370 on an exchange-rate basis, it rose to $1,950 when adjusted to purchasing-power parity. If this figure is multiplied by the large number of Chinese citizens, that would credit China with an economy about the size of Germany. On the other hand, if ranked by GDP per capita, China is very much a developing country and still among the world’s 30 or 40 poorest nations.

Since the "open door policy" was implemented in early 1980’s China has obtained its rapid growth mainly from two engines: the development of foreign trade and the attraction of Foreign Direct Investment (FDI), both elements being closely correlated. Since most foreign investments are concentrated in the export-oriented sector, FDI plays a significant role in promoting China’s exports. During the period 1989-1991, the Beijing government implemented profound policy reforms to facilitate foreign access to China’s domestic market in order to acquire enough capital inputs for the modernization of the country’s underdeveloped economic infrastructure.

Indeed, foreign currencies, mainly US dollars, originating in growing exports and FDI inflows allowed the country to accumulate huge amounts of foreign exchange reserves that helped to support the national currency and to fund the expensive capital and technological imports the reforming economy demanded. Thus, the influx of FDI has reduced China’s shortfall in capital and has, therefore, greatly contributed to the economic development of the country.

FDI in China has been concentrated mainly in labour-intensive manufacturing industries, so the FDI inflow has promoted export growth and, subsequently, economic growth. The high rates of growth achieved and the potentiality of the biggest consumers market in the world attracted an increasing inflow of FDI to the economy. More than 100 countries have up to now invested in China. Overseas Chinese from Hong Kong, Macao and Taiwan account for more than 75% of total foreign investment, in terms of both investors’ numbers and amount invested.

Furthermore, the US, Japan, Singapore, Britain, Thailand, Canada and Germany have earmarked significant amounts of capital investments to the enticing Chinese market. The implementation of market-oriented reforms has encouraged even more foreign capital inflows to China’s economy, thus further stimulating economic and industrial development.

Most foreign resources are allocated into export-oriented manufacturing industries but, lately, and due to the structural changes in the economy, the pattern of investment has been changing as well. Although the manufacturing industry still accounts for the larger amount of FDI, the inflows are now being concentrated more intensively on infrastructure development.

The better location and infrastructural development of the southern coastal provinces has resulted in a clearly biased reception by geographical destiny. As a consequence, income levels in these provinces have been rising more rapidly than in other regions, thus bringing about gaping income disparities and an ever widening development gap. For instance, coastal areas and big cities account for 75% of the total FDI; among them, Guangdong ranks first, as it accounts for no less than 30% of the total amount of FDI.

TABLE 1:

FOREIGN DIRECT INVESTMENT IN CHINA

Source: China Statistical Yearbook

This is precisely why, Chinese authorities are now encouraging investors to fly into the inland provinces, too. As a result of this incentive, and also due to the rising production costs in the wealthiest Special Economic Zones (SEZs), FDI has been slowly spreading to other regions, but the extent of regional disparities remains substantial and constitutes one of the principal challenges Beijing is called on to face in the future.

In 1997, utilized foreign investment rose by 8.5% to US$ 45.28 billion, though the number of foreign invested projects and contracted foreign capital declined by 14.4% (see Table 1). The suspension of tariff exemption for equipment and machinery imports enjoyed by foreign-invested enterprises in 1997 contributed to the slower growth of foreign-invested projects and contracted foreign capital in the year. According to official figures, by the end of 1997 more than 145,000 foreign invested enterprises started operation employing at least 17.5 million local workers (10% of the national total non-agricultural labour force) and generates about 14.9% of the national industrial output.

However, many foreign firms bitterly complain about the heavy and slow bureaucracy and the lack of transparency at the time of policy implementation (for instance, announced reductions on foreign value-added taxes have never taken place). The crisis itself could affect China in a different way, as foreign firms are now considering acquiring cheap existing assets in sale in the troubled economies instead of putting new capacity in China.

3.3. Challenges for China

3.3.1. Regional Disparities

Apart from external threats, a grave problem to be reckoned with is China’s internal lack of regional cohesion, as the disparities between China’s coastal zone and mainland are worrying indeed. Thus, some form of fragmentation of China may indeed become a possibility; as a scenario, at least, such a development should not be discarded light-heartedly.

Since the first years of the reform, the southeast coastal region and the biggest cities have performed faster than the central and western regions. The disparity between the eastern and western provinces of the country persists even today and the gap is widening at an alarming pace. Reducing regional and income disparities is now a priority for the Chinese government, which is why lately Beijing has been investing substantial amounts in infrastructure projects ($1 trillion over three years) to contribute to the development of inner China and thus to facilitate a certain shift of the FDI from the coastal areas to the even "lower labout-cost" interior regions.

On the other hand, the fragmentation might start out on purely fiscal grounds, and develop into a general crisis. For instance, if the rich coastal regions, led by Guangdong and Shanghai, go their own way, Tibet and parts of Xinjiang, culturally distinct from the rest of China, might seize the chance to break away altogether. Any sort of military break-up would increase the chances of local conflicts along volatile borders, particularly in places with rich energy reserves - for example, off the South China coast, where China is one of six countries claiming ownership of the Spratly Islands and the oil fields that may surround them; in the north-east, where China’s main onshore oil fields are located and where Russia is at its most unruly; and in the Tarim basin of Xinjiang, which has a Muslim minority and Muslim neighbors.

The conventional argument against such a contingency is that China, for all its civil wars and provincial protectionism, has held together in substantially its present form for most of the past 2,000 years, and large sections of it for at least 4,000 years. In this case, nation and race are looked upon as being almost coterminous.

3.3.2. The Management of State Owned-Enterprises (SOEs)

Although in 1997 a certain amount of improvement in the performance of state enterprises took place, their losses and inefficiency continue rising. Now, after Premier Zhu Rongji’s ambitious announcements, China’s economy is geared - hopefully - to restructure the problematic SOEs sector within a three years’ time. This high-risk political decision enhances the possibility of a serious economic slowdown.

For instance, the privatization programme implies restructuring 305.000 SOEs that employ more than 100 million workers. Due to the fiscal and financial reforms in the 1980s, SOEs receive less subsidies from the state budget. Nevertheless, they still receive "quasi-subsidies" from the state banks in the form of so-called "policy loans".

Furthermore, it should be noted that SOEs in China account for nearly 50% of the country’s exports and thus play a remarkable role in maintaining export growth. Since SOEs do not operate on a profit basis they prefer to sell, despite eventual losses, instead of firing employers.

The main reason behind the delay of the financial sector reform is the need for the state to mobilize financial resources to maintain the inefficient SOEs. But with an easier access to the banking credit, the average debt-asset ratio of the SOEs has increased to 80% by now. Bad loans were estimated officially as 25% by the end of June 1996 and the inter-enterprise debt (IED) (triangular debt) increased sharply in recent years. As a result the IED/GDP ratio is now 42.99, which is among the highest in the world.

3.3.3. Rising Unemployment

As a result of the combination of several factors, and after more than 30 years of solidarity and socialism, the Chinese economy is now suffering from the "unemployment disease". The main reason behind that is related to structural disequilibria: technological progress and the increasing use of capital has not been accompanied by a respective increase in the amount of investment-generated employment.

China has a huge population with a poorly balanced rural-urban structure, as 800 millions, or some two thirds of the total, still work in the countryside. The economy is now stalled at the lower stage of the economic cycle, and insufficient demand increases unemployment even more.

In this regard, and considering as well the negative impact of fast privatization program, the lack of a uniform social safety net will we unable to support the eventual surge in the number of laid-off employees emerging from the acceleration of enterprise reform.

3.3.4. Insufficient Fiscal Reform

At the beginning of the 1990s, two major aspects of the fiscal system were worrying the Chinese reformers: the decline in government revenue as a proportion of the GNP and the difficulties in central-local relations which were seriously affecting revenue mobilization. Hence, the government launched in 1994 a fiscal reform, a set of measures to improve the quality of this relevant tool in terms of both political economy and macroeconomic control.

Despite the remarkable efforts to rationalize and modernize the fiscal system in 1994, China’s fiscal revenue over GDP is not raising as expected constraining, therefore, the budget necessities to support the development of the infrastructures and the creation of any kind of social security system. The still primitive stage of the fiscal instruments prevent the government for using a coherent and efficient fiscal policy to counterweight the fluctuations of the economic cycle and some of the macroeconomic disequilibria. Besides, the obscure division of power and the unclear fiscal responsibilities distribution between central and local government keeps on contributing to worsen the scarce rate of tax collection.

A key element of this problems is the position of the SOEs. Their poor profitability is, in some extent, responsible for reductions in government revenue and, at the same time, they are responsible for increases in loss subsidies as well. Financing its wage bills, their high levels of investment and their growing losses, is pressing the monetary supply to expand, partly difficulting macroeconomic control. Enterprise reform is seen, therefore, as a fundamental to the establishment of a satisfactory fiscal system.

In addition to the already mentioned problems, other aspects of the fiscal system need reform in order to allow the market to function properly. The fiscal system must encourage labour mobility to facilitate the transfer of workers from unprofitable enterprises to new working opportunities in the economy. In this regard, reform of the pension system, unemployment insurance and housing provision are previous steps to accomplish. These reforms will help the SOEs privatization plan by making their costs more closely related to efficiency and by allowing enterprises to go bankrupt.

3.3.5. Increasing Energy Demand

Since the early 1990s, China’s trade balance in energy has sharply deteriorated, propelled by double-digit economic growth and the transition to a consumer economy. In November 1993 the country became a net importer of oil for the first time in more than a quarter of a century, and the deficit has since soared to about 600.000 barrels a day.

Recent estimates from the Asia-Pacific Economic Co-operation (APEC) organization suggest that China’s net external requirements will rise to over one million by 2000 and nearly three million by 2010. By 2015, less than two decades hence, Shell China Petroleum Development estimates, Chinese imports of more than seven million barrels per day will approach the current imports of the United States.

Generally speaking, there is a fair possibility that Asia’s energy rivalries could become dangerously politicized, especially in an oil crisis, and China’s role in such a contingency is more than obvious. Rapidly increasing energy consumption in the area is precisely why the South China Sea is the flash point for regional tensions.

Due to the inexorably rising flow of oil through the Strait of Malacca, ensuring the security of the South China Sea ways and of the pivotal states that dominate them - particularly Indonesia and India - should loom larger and larger on the long-term security agenda of East Asia. It is highly indicative that in the South China Sea lie the maritime routes that supply 70% of Japan’s and South Korea’s oil imports and growing portions of other Asian nations’ energy needs.

After this brief review, it is obvious that, despite the great success and the impressive results achieved by the Chinese economy during the last 20 years of reform, China is still very much a developing country facing some serious development constraints in the medium and long term. In a way, the biggest challenge for Beijing seems to lie in the clash between the country’s internal backwardness and its increasing international importance.

4. China’s Presence in East and Southeast Asia

   4. 1. China Proper and Greater China

Over the years, many scholars have referred to the Chinas as a multiple - two Chinas, three Chinas, and more. They have in mind the fact that several of the major economies of this region have a predominantly Chinese population and an unusual degree of interaction. According to official figures, mainland China’s 1.2-billionth baby was born in February 1995, and the 1.3-billionth is expected before the year 2000. China’s population was reported as amounting to 1.236 billion at end-1997.

Since July 1997, Hong Kong has been integrated as an autonomous province of the People’s Republic of China (PRC) - Hong Kong Special Administrative Region (HKSAR) - even though the political and economic status of this enclave remains to be elaborated in the future.

  4.1.1. The Chinese Diaspora

The six million inhabitants of Hong Kong are no doubt of Chinese origin, but things appear somewhat complicated in another area, which has traditionally belonged to the Chinese civilization - the Republic of China (ROC) in Taiwan. The political and, allegedly ethnic, split between the mainland and Taiwan dates back to 1949, when the nationalist government of China fled to the island. It would appear that some significant changes have occurred in Taiwan over the last five decades in terms of self-identification of the inhabitants, to the effect that a large number of them now regard "Taiwanese" as a separate ethnic identity. Yet, particularly revealing are the results of a survey carried out in Taiwan during the 1996 presidential elections. According to this study, it appears that half the citizens of Taiwan consider themselves to be either Chinese or both Chinese and Taiwanese.

A sizable Chinese population lives out of the country’s boundaries, too. Thus, in Singapore, 77% of the local population is Chinese, compared to 14% of Malaysians and 6.5% of Indians. In Malaysia, Chinese would account for no less than one third of the total population and would, effectively, be in possession of the economic power in this country. Ethnic Chinese, either Han or not, are scattered around in practically the whole of East and Southeast Asia, from the eastern parts of Russia all the way to Oceania.

  4.1.2. The Economic Weight of Overseas Chinese

On the other hand, China’s looming presence in the area is not fathomed only in terms of population, but primarily in economic weight. Overseas Chinese companies in Malaysia, Thailand, Indonesia, and the Philippines make up about 70% of the private sector in those economies. More specifically, ethnic Chinese account for only about 10% of the population of Thailand and 9 of the 10 largest business groups in the country. In Indonesia, no more than 4% of the population was Chinese till late 1997; yet, 68% of the top 300 conglomerates were owned by local Chinese entrepreneurs.

The case of Indonesia is fairly indicative, as the Chinese were a frequent aim during the riots in early 1998 that eventually led to Suharto’s fall. On the one hand, Chinese Indonesians were seen as disproportionately wealthy, particularly in the midst of the severe financial crisis in the region, and as undesired for a variety of reasons. The massive exodus of ethnic Chinese from Indonesia in the wake of the clashes poses two major questions: i) will Indonesia’s economy be deprived of the business presence of its ethnic Chinese, and ii) will Beijing put pressure on Jakarta to respond in some way?

Thanks to ethnic kinship, the overall Chinese economy includes such rapidly growing areas as Taiwan, Hong Kong, Macao, and Singapore. On the other hand, China’s economic influence is just as strong in other countries of the wider area, too. Despite the current Japanese dominance of the region, the so-called "bamboo network" or "Chinese-based economy" is emerging as a new epicenter for industry, commerce, and finance. This strategic area contains substantial amounts of technology and manufacturing capability (Taiwan), outstanding entrepreneurial, marketing, and services acumen (Hong Kong), a fine communications network (Singapore), a tremendous pool of financial capital (all three), and very large endowments of land, resources, and labour (mainland China).

Frequently, China’s business ties involve dealings by overseas Chinese with people in the China proper from which they or their ancestors migrated. Thus, Hong Kong has provided about 90% of the investment in adjacent Guangdong, avowedly the most rapidly growing area of China. On the other hand, it is practically the whole coastal zone of China that has greatly benefited from commercial links with Hong Kong. 75% of all foreign investment in China has been made by Hong Kong’s Chinese entrepreneurs and is spread out over 17.000 enterprises. Apparently there are far more people working in China for business owned by Hong Kong or on orders received from them than the entire manufacturing work force of Hong Kong itself (in a proportion of 4 to 1). Similarly, up to 1995 over 5.000 Taiwan enterprises had set up factories in China, mainly in the South, or otherwise invested an aggregate of $5 billion in mainland businesses.

  4.2. The Security Puzzle in East Asia

         4.2.1. China’s Security Priorities in the Region

Beijing’s security priorities are perhaps best set out in a book entitled Zhongguo nengfou daying xia yichang zhanzheng ("Can China Win the Next War?"), published in China in June 1993 and in Hong Kong in January 1995. The authors of the book cite eight items as posing direct threats to China’s security, unification and territorial integrity.

The specific threats identified by Beijing would be the following: "... the dispute over ownership of islands in the South China Sea, the use of military force by South Korea against North Korea, the confrontation on the "roof of the world" (the dispute between China and India), and the issues of Taiwan, Hong Kong, Tibet, Xinjiang and Inner Mongolia. China’s five hypothetical enemies are: "our openly acknowledged opponent and the world’s top military power, the United States", "Japan, re-emerging as an enormous opponent", "the unfathomable super-murderer, Vietnam", "the greatest potential threat, India", and the "still-imposing menace, Russia". Moreover, the situation has become particularly exacerbated by the recent nuclear arms race between India and Pakistan in early 1998.

What has proved a major riddle in the security puzzle in the area is the recent dispute between China and Taiwan, accompanied by considerable military tension. The 1996 presidential elections in Taiwan were viewed by Beijing as a dangerous step in the direction of a separate state entity. Apart from sabre rattling, Beijing pursues to exert pressure on the island’s authorities through the GATT, which China had left in 1950, and so to win its place as a founder-member of the GATT’s successor, the World Trade Organisation.

Because matters between China and Taiwan are questions of sovereignty and national unity, Beijing can make few concessions or compromises, and by consistently maintaining a hard line, Premier Jiang Zemin could solidify his position as the leader after Deng. On the other hand, the people of Taiwan are not so naive to take Beijing’s threats at face value; nonetheless, Taipei will almost certainly be forced to make major adjustments in its policy of "de facto independence" and switch to a more cautious foreign policy.

As regards Beijing’s relations with the Korean peninsular, China’s relations with the two Korean states have undergone considerable changes in the post-cold-war period. On the other hand, it has been observed that the Chinese government is reluctant to expand its military and economic co-operation with North Korea. Therefore, China is now expected to deal with both Koreas at equidistant in the years to come, at least because it has a keen interest in economic co-operation with South Korea, and because of the likely unification of the two Koreas.

Despite adverse tradition, Sino-Russian relations have seen an impressive thaw in the 1990s, culminating in President Yeltsin’s official visit to Beijing in early 1996. What has caused serious concerns in other East Asian countries are the recent Russian supplies of military equipment to China; furthermore, Moscow and Beijing appear to have agreed on co-production and the transfer of high technology in this sector.

However, a notable Sino-Russian rapprochement is being observed in the energy sector as well. China’s rapidly growing energy demand has clearly driven Beijing towards closer co-operation with Moscow on issues pertaining to the exploitation of Siberian oil and gas reserves This development is seen by many as a step forward on the part of China to both meeting its rising energy needs and reducing its.dependence on Gulf suppliers.

    4.2.2. China and the US: Towards a Special Relationship?

In terms of FDI and trade, China is a major and increasingly important partner of the US in the Asia-Pacific area. Even before the current financial crisis, China had become a major destination for FDI. In 1991, Thailand would absorb up to 10% of the overall FDI in Asia and China 20%; in 1994, Thailand’s share dropped to 1.3%, whereas China’s soared at 67%. Malaysia, in turn, saw its share shrink from 20% to 8% over the same period of time. It is obvious then that China can only be seen as a major partner of utmost importance in the region.

Of course, Sino-American relations have been marked by serious disputes over trade issues, not much different from the recurrent tension between the US and Japan. This resemblance has already been pointed out and ushers in the issue of a complex trilateral relation in East Asia to be reckoned with. For instance, Japan retains its overall trade surplus with both the US and most Asian countries; Asian economies, including China, have a surplus in their overall trade with the US; that way, the US is the largest importer in the world and retains an enormous trade deficit. However, will this structure live on under the new circumstances? If yes, for how long? If no, what will have to change and will that require a more active part of China in the whole process?

As regards US involvement in the dispute between China and Taiwan, during the US-China summit in late October 1997 President Jiang Zemin was pleased to hear President Clinton’s clear-cut statement that the US remains committed to a "one China policy" and that it is up to Beijing and Taipei to resolve their differences peacefully. On the other hand, China recognises that it is not practical for the US to stop arms sales to Taiwan in one single step; what China wants is a clear statement that the US would not encourage moves in Taiwan towards independence.

Several month later, the visit of President Clinton to China in June 1998 caused another torrent of comment on Sino-American relations. This important event came eight months after Jiang Zemin visited the US, and nine years after the 1989 Tiananmen unrest. It is yet to be seen whether the emerging strategic partnership between Washington and Beijing will be a constructive and lasting one, but it is obvious now that the two countries are coming closer together.

In a way, both the US and China are superiors in their respective categories: they are the largest developed country and the largest developing one in the world. They both have a sense of responsibility in terms of world economic stability and security; despite their differences (e.g. security perceptions as well as trade and human rights issues), they certainly share extensive common interests, underlying this impressive rapprochement.

5. China’s Future Prospects in the Region

    5.1. China in the Post-Cold-War World

Chinese leaders seem to realise that the bi-polar system created by the US-Soviet rivalry during the Cold War era is now being replaced by a multi-polar system. In these circumstances, they begin to think about the new role to be played by China as the great power in East Asia. In the 1990s, China’s security policy and diplomacy have no doubt been driven in the same direction of increased capability of self-help, as evidenced by its ambitious plan for the defence industry, its ever-increasing interest in arms sales abroad, and its stubborn territorial claim to the islands in the South China Sea.

With Japan striving to reach a great power status not only in economic terms but also in political terms, and as long as the US wields its hegemonic power in world politics, China is unlikely to remain satisfied with being just one of the many ordinarily powers. The current drive for modernisation and the military build-up in China clearly suggest that the nation is heading for a great power status in Asia.

   5.2. An Emerging Regional Superpower?

Perhaps the most important question is not whether China will dominate the region in the years to come, but what reactions this will bring about in neighbouring countries. Thus, what has caused considerable concern in neighbouring countries lately is the peremptory fashion in which China undertook its last nuclear tests in 1995 in Xinjiang in the face of international opposition and, of course, the question of Taiwan, as these incidents are seen as signs of a latent Chinese nationalism. True, China’s agenda might include attacks on Taiwan and Vietnam, hardline repression in Hong Kong, and border disputes with Kazakhstan and Russia, and a nightmare confrontation with India. The authors of this paper tend to think that there are at least two factors which may well prevent these worst-case scenarios from coming true.

Firstly, it is held that because of the increasingly seamless global economy the new Asian order will perforce encompass the entire region with no regard to the borders of nation states - meaning that a hegemony will inevitably be required to maintain it. At first sight, Japan would seem well-suited to perform such a task in East Asia, but then China has been gaining ground, too. Indeed, in former times

"... the multinational, highly decentralised Chinese empire lacked the prerequisites to form a nation state ... but today the rapid development of a borderless capitalist economy and myriad other transnational phenomena would appear to establish the conditions for the rise of a new Chinese empire...In other words, the traditional system of loose imperial control, that has long been blamed for China’s relative backwardness, could in a borderless world allow China to turn the tables on today’s leading nation states, which suffer from overstability".

According to this school of thought, China’s future depends above all on whether Beijing succeeds in forming a new kind of "imperial order" in East Asia, one that is adapted to the realities of globalisation - the spread-out of networks allowing people, goods, money, information, and even crime, to move easily and rapidly across national borders. If it manages to do so, the fact that China lagged so far behind Japan and the West in developing a modern nation state and has yet to establish a market economy on a national scale may turn out to be a blessing in disguise. Because China never developed into a modern nation state, its economy and society will not be adversely affected when they are sucked into the maelstrom of globalisation. Globalisation is, after all, about the proliferation of transnational networks and the development of economic activities that escape the control of states.

Secondly, there are various carrot-and-stick factors which should not be neglected. Insomuch as the US remains an Asian-Pacific power with the high level of military capabilities at hand, Beijing is unlikely to try to challenge the American interests and principles. Chinese analysts fully expect the US to get involved in any war between China and Taiwan as part of the American strategy of holding Chinese power in check, and rate the US Seventh Fleet a formidable opponent to contend with.

On the "carrot" side, it is not insignificant that China benefits tremendously from its spectacular economic growth. For example, the powerful economies of Hong Kong and Taiwan, among the world’s top holders of foreign-currency reserves, and the economy of the mainland are in the process of creating a very good complementary relationship. After all, the success of Taiwan’s economic development was a major force behind the mainland’s decision to abandon a planned economy and switch to market mechanisms. Therefore, considering the depth of their economic co-operation, it seems doubtful that China would be overly assertive, and that Taiwan could turn its back on the mainland and opt for independence. By the same token, it is highly unlikely that Beijing will resort to excessive hardline policies in Hong Kong.

Leading Chinese analysts appear convinced that the cold-war arms race no longer constitutes a meaningful response to the challenges of the new era.

"In fact, such a change is a natural consequence of the Cold War. Of the two major opponents, the US and the USSR., one [came out] wounded and the other collapsed, both caused by overstretching themselves and being overburdened with an ever-escalating arms race."  

It has been suggested that China will probably help North Korea, so as to prevent its collapse, while trying to absorb the North Korean economy into its economic community. Similarly, rather than confronting other East Asian countries militarily or politically, it is in Beijing’s best interest to engulf them in the Greater Chinese economy. That way China’s looming presence in the area will be viewed as less threatening and perhaps even desirable.

    5.3 Could China Prove the "Saviour" of the Region?

The current turmoil in the Asia-Pacific has posed a number of painful questions about the sustainability of growth in the region, but also about the balance of power in this turbulent part of the world. Both groups of issues relate primarily to Japan and China, the two indisputable regional superpowers.

While Tokyo has appeared like a steady point of reference for at least four decades after World War Two and China has been looked on as being a vast but unruly country, things may well be changing now. China’s strong growth amid regional sluggishness has helped it displace Japan as a force of stability in dealing with the current crisis. It is a fact that the world’s most populous nation is a true economic giant, with a population ten times the size of Japan. Indeed, many in Japan have used Clinton’s recent visit to Beijing - without a stopover in Tokyo - as a symbol of Japan’s diminishing clout in world and regional affairs.

At the same time, other countries in East Asia have posed the question whether Tokyo is up to the to the task it has been performing for nearly half a century in the area. Thus, ASEAN has urged Japan (as well as other G-7 countries) to lead international efforts in resolving the regional financial crisis. It seems, however, that at the this very moment Tokyo has its own domestic concerns to pay attention to, and this may well give room to China to aspire to East Asia’s leadership.

On the other hand, whether China is entitled to a leading position in the area or whether Japan will be willing to accept a subordinate role may not be totally relevant. After all, the financial crisis in the region has affected the whole world and thus mobilised a wide variety of international players.

Both the IMF and the US have taken prompt action in response to the crisis of Asia’s financial markets. However, the nature and extent of this assistance have been heavily disputed. Therefore, it is be an enticing topic to explore whether China could undertake a larger part of this rescue mission in the wider region. After all, until recently, some analysts would add up the foreign exchange reserves of the various Chinas and come to a present total of $305,52 billion, an amount far in excess of the foreign exchange holdings of any other economic power, even Japan ($222 billion).

One of the possibilities for consideration would be for China to open up to the afflicted economies of Southeast Asia and thus help the countries of the region stand up to the feet once again. On the other hand, an export-driven China will clearly be reluctant to do so immediately. Small wonder then that Chinese monetary authorities are already tempted to depreciate the national currency, in order to prevent an anticipated drop in exports.

It should be borne in mind that the Chinese economic miracle has been increasingly export-driven. Given then that the Asia-Pacific area constitutes the most important market for Chinese exports, the 1997 crash in most southeast Asian countries could not possibly have left China uninfluenced. "In exactly what way it has been influenced?" would be the question.

Since the Asian financial crisis explosion, mainland China has suffered the fewest consequences of any nation because of its lesser degree of financial liberalization. But, the problems riddling mainland China’s financial system have already created the urgency of deepening financial reform. Since reform of the financial system and the establishment of a legal system governing finance lags many years behind reforms in other areas of the economy, the rapid influx of capital and expansion of financial activity has resulted in a large number of major financial disturbances. Starting in the closing months of 1997 and continuing to the present, Western public opinion has been concerned with whether China will experience a financial crisis like the rest of southeast Asia and weather the financial turmoil in the region could affect China’s foreign trade eventually leading to currency devaluation.

    5.3.1. The Renminbi Issue

              The Temptation to Devalue

As the world’s seventh largest economy, China’s exchange rate policy has been carefully observed since the crisis’ burst. After the severe round of devaluations in the region some voices have suggested the renminbi would be devalued for the sake of the Chinese competitiveness. However, this has not yet happened and in the short run devaluation is unlikely to occur. Looking into the fundamentals of the Chinese economy in 1997 one may even argue macroeconomics suggest the currency is in fact undervalued: growth rate is expected to reach 8% in a fast declining inflationary path, foreign exchange reserves continue increasing as a result of strong capital inflows and a $40 billion trade surplus (see Table 2).

TABLE 2: MAJOR ECONOMIC INDICATORS OF THE

CHINESE ECONOMY, 1997

Source: China Statistical Yearbook

An eventual devaluation of the renminbi could damage the outstanding foreign direct investment inflows that make China the second largest FDI recipient of the world. These capital inflows incorporate a high added value since they are the main source to finance the modernization of the economic structure and, hence, one of the keys to maintain the high growth rates the government requires to legitimate the communist monopoly in the rule of power. Indeed, foreign enterprises invest in China on a long run strategy which assumes exchange rate stability to foresee stable dollar returns on their investments. Hence, an unexpected devaluation of the renminbi, by reducing the future returns, could discourage the already decreasing contractual FDI in China (see Table 2).

It is true that the sharp devaluations that followed the acute crisis of the Thai currency, the baht, did have some impact on the competitiveness of Chinese exports, but exchange rates are not the unique determinants of exports policies. In that regard, some other factors must be taken into consideration, such as, for instance, product complementarity/substitutability, and the amount of capital, labour and technology embodied by the export production process.

In other words, the fall in the yen or in the won may not affect China’s exports so much as the rupiah devaluation. Japanese and Korean exports are more capital- and technology-intensive and, compared to China’s, are complementary exports and not substitutes. The case would look different, when considering the southeast markets because Thailand, the Philippines and Indonesia supply the international markets with more substitute exports, such as textiles and garments; yet, Chinese exports are more diverse than that (see Figure 4). Furthermore, Chinese competitiveness remains superior due to the fact that its labour costs, the cheapest in the region, are still under the average.

Moreover, devaluation will probably produce inflation as far as imports still account for 20% of China’s GDP. Strong devaluating currencies in the region will not help compensate the negative effect on imports of an eventual renminbi devaluation as round 85% of them come from industrial economies and Hong Kong - so far, not yet affected by the crisis.

From a broader perspective, deepening in the international economic community, the United States will undoubtedly not welcome a renminbi devaluation. The United States trade deficit vis-á-vis China has become so large, than even now it surpasses its traditional great deficit vis-á-vis Japan. A wider trade deficit with China will trouble the Clinton’s Administration in a moment of alleged Chinese financial support to the last general elections, in a context of hard pressing lobbies pursing the containment of China ranging from labour unions protests to human rights activists. By all means, a competitive devaluation to seek gains in the terms of trade does not seems to be the most smart policy to avoid the United States negative to accept China’s membership to the World Trade Organization (WTO).

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FIGURE 3: THE COMPOSITION OF THE CHINESE EXPORTS, 1997

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5.3.2 China’s Export Engine

Despite the collapse of the markets following the currency crisis in the region, China’s export performance and trade surplus volume has not been substantially affected. This fact has been the key to contain the crisis for the sake of the regional -and to a certain extent, international- stability. A drastic drop in Chinese exports, one of its precious growth engines, could have generated strong pressures towards a devaluation of the renminbi, thus triggering a new round of devaluations and aggravating the current stage of the crisis.

It is a fact that China’s export growth is slowing down as neighbouring markets contract and, for the first quarter of 1998, China saw its exports rise by a mere (!) 12.8% on a year earlier. No doubt China’s economy will not be able to match the 20% year-on-year growth rate of previous times. Official data show that, amidst the current financial crisis, China’s exports to ASEAN, Japan and South Korea have dropped by 9.5%, 3.1% and 24.5%, respectively.

Nevertheless, exports to industrial markets beyond Asia performed surprisingly well and helped compensate the declining regional sales. Thus, exports to Europe grew by 35% on a year earlier, whereas those to the United States exceeded 14%. These two markets together account for near 40% of the total and the uprising behaviour registered in the first quarter of 1998 is enough to offset the regional drop in China’s exports (see Figure 4).

The reason behind this balanced export growth is twofold: on the one hand, it has much to do with China’s own capabilities and, on the other hand, with the economic and financial disarray in the export-driven neighbouring economies. More specifically, China enjoys long-term competitive advantages in its highly trained and low-cost labour force as well as in its fast growing productivity gains. At the same time, the economic chaos in the affected economies and the severe rescue programs imposed by the International Monetary Fund (IMF) makes it hard - sometimes impossible - to finance the imported items the export-driven assembly lines in southeast Asia need to keep on working.

In this perplexing situtation, at least three intriguing questions arise: "What are China’s prospects for the near future?", "Will China be able to keep exports growing?" and "Will China remain on the international integration track?". It has already been pointed out that, despite its good performance within a crisis environment, China’s foreign trade is definitely shrinking; recent Chinese official estimates shows exports declined 1.5% in May in comparison to 1997, so did imports in 3.8%.

As a result of the fall of the yen big foreign enterprises in China fears an eventual devaluation of the renminbi and, therefore the country’s authorities have been cutting down on investment. Despite this slight reversal, Chinese officials firmly maintain the economy will be able to close 1998 with trade surplus and, hence, will not have to devalue the renminbi. In fact, official figures show trade surplus for the first five months accounted for $185.3 billion and foreign reserves increased during the same period in $1 billion.

Moreover, considering the years to come, the sharp privatization scheme to be applied in the SOE sector will damage its capability to freely borrow from the state commercial banks. The increasing number of bad loans and triangular debts in the obsolete Chinese financial system and its urgent need for reform, have dangerously increased the financial risk. In many Asian countries a contributing factor to the crisis was the political nature of lending. These loans, lent not in conformity to economic and risk principles, provoked a severe bad-debt situation. The yet-to-be reformed Chinese financial sector is facing the danger of collapse, because of the shocking proportions of bad debt problems. Banks have a very high loss ratio, and their assets were long ago outstripped by their bad loans.

SOEs do not have the attitude that loans must be repaid, nor they receive any policy pressure to pay back. A SOE that can make interest payments is considered a fine performer but the majority does not. Large scale unpaid debt to banks started with the so called "Grants to Loans Policy". Bad debts began to accumulate in 1983 and in summer of 1995 a total of Rmb 3.5 trillions in bank loans went to state enterprises and the debt ratio state-owned business assets, as already mentioned before, was about 80%.

Most analysts believe that the reason China has not suffered from the financial crisis like the rest of the southeast economies is because of its highly protective financial market and the limited convertibility of the national currency. Another important factor could be pointed out, too: China’s banking system is controlled by the state and will be undoubtedly obliged, under this peculiar framework, to be the saviour of any eventual financial crisis. But the fact that the signs of the crisis are not visible does not mean the crisis does not exist. Financial risk is reaching perilous levels and increasing ratios of bad loans do not help solve the problem.

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FIGURE 4: CHINESE EXPORTS BY DESTINATION, 1997

Note:

* Indonesia, Malaysia, Philippines and Thailand

** Includes re-exports

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Now that the economy has turned to the micro level changes and is undergoing the most risky and dangerous step in the history of the economic reform, the privatization of the SOEs, maybe the matter to be discussed is not the possibility of a currency devaluation crisis, but rather the economic and financial problems of the second largest economy of the region, existing even in the absence of an eventual financial turmoil.

5.3.3. China’s Role In Containing the Crisis

A devaluation of the Chinese currency could reignite a new round of devaluations aggravating the current stage of the crisis and erasing all the hardly achieved recovery signals. In a sense, China has the remarkable opportunity to support East Asia’s recovery by sustaining its national currency and, thus, enhancing its new "regional superpwer" role and reputation. The region accounts for 60% of China’s exports and more than 70% of FDI inflows. As Asia’s second largest economy and powerful political actor, China’s policies have immense repercussions and, therefore, its behaviour is crucial in containing the financial turmoil, especially now that Japan, "Asia’s locomotive", is suffering from a long and profound economic depression creating some uncertainties about its own regional leadership.

This argument leads us to the following questions: "Does the financial crisis signal the start of a shift in the region’s economic leadership?", "Is the just-awaken dragon taking the place of the second largest world economic superpower?", and "Is China ready to turn into a new growth and stability engine?"

One cannot ignore the remarkable role China has played in containing the crisis at a moment when even the Japanese locomotive has derailed. The "no devaluation policy" saved Hong Kong from the worst financial turmoil in the region and somewhat helped absorb the shock of southeast Asia’s collapse. However, even in the case China’s economy successfully goes beyond the obstacles on the road to capitalism, it is not ready to take over Japan and provide a similar kind of economic leadership.

Up to 1996, China clearly did not yet have the financial, technical and managerial resources to take care of the region as Japan has done so far (see Table 3). Notwithstanding the big troubles Japan has been facing since the explosion of the "bubble economy" in 1991, it will remain the region’s economic leader for the time being. However, Tokyo cannot overlook the fact that China is rapidly catching up and, indeed, Beijing may well turn into the region’s leader into thefirst decade of the next century.

TABLE 3:ECONOMIC IMPACT OUTSIDE BORDERS (US$bn)

Note: All figures for 1996, except imports

Source: International Monetary Fund, China Statistical Yearbook, Overseas Economic Cooperation Fund (Japan)

However, given that China’s export machine will hardly remain unaffected by the crisis and that, at the same time, imports are growing very slowly, the possibility of devaluation may become more realistic in the future. If that should be the case, China could be seen as more of a competitor than as a "saviour" of the region.

Plagued by its own internal problems and still insufficient level of development (see Chapter 3.3), today’s China is far from achieving to pull the region out of the slump in the short run. Therefore, it would be more accurate to argue that rather than China taking the role of Japan, Japan is not playing the role it should.

Yet, the mere fact that the question of China taking over Japan is being posed underlines the significant changes in East Asia over the last two decades. It is widely acknowledged nowadays that within some twenty years after the demise of Mao Zedong China has come out of its isolation and has acquired the status of a power to be reckoned with. Whether we are witnessing the emergence of a world superpower remains to be seen; however, few doubt today that East Asia already has its 21st-century regional leader.

6. Conclusions

East Asia’s regional context is anything but favorable for the kind of economic growth and political stability enjoyed, for instance, on both sides of the Atlantic after World War Two. The Asia-Pacific and East Asia, in particular, is heavily burdened with animocity and downright conflict to emulate the US and Europe. China is still very much part of the problem, although it is trying to appear as part of the solution.

In terms of development, China has followed a path of its own, one that does not precisely coincide with other patterns adopted in east and southeast Asia. Among other things, the "open-door" policy ushered in nearly two decades ago has greatly contributed to the impressive growth of the world’s largest country. Today, China has turned into a kind of huge "sponge" avidly absorbing a considerable portion of global FDI.

The attraction of FDI has also contributed to the shift in China’s international behaviour. Its long-lived isolationist attitude has been replaced by a notable willingness for closer integration in both regional and global structures. Isolation and military confrontation are now being seen in Beijing as irrelevant within the new world order, in which China should claim its role by other means.

Thus, Beijing’s post-cold-war security doctrine renders open military action less likely. Although in the dispute with Taiwan, the most exacerbated of China’s security issues, Beijing’s stance is to stick with the two-edged sword of war and peace, it is clear that self-imposition by military means is inferior to unification by peaceful means.

What is a conspicuous development in terms of international politics is the fact that the US has been paying increasing attention to Bejing. Nine years after the Tiananmen events, Washington appears willing to consider the formation of a strategic alliance with the world’s largest country. The nature and extent, however, of this partnership may emerge as a clear-cut concept well into the next century.

The economic might of the world’s largest country is obviously a factor to be reckoned with. Apart from China’s impressive macro-economic achievements, social and economic development is not seen as a self-fulfulling goal, but also as a tool to be used by Beijing in assuming a leading position on a global scale. Yet, despite the impressive growth rate of post-Mao China, there are a number of difficulties ahead.

Internal troubles run over a wide range of headaches, from regional disparities and foreign policy to the enormous task of reforming state-owned enterprises (SOEs) which are currently employing many millions of workers. To make things even worse, the Chinese authorities will have to come up with efficient solutions to the inter-enterprise debt tangle. Simply shutting down SOEs or privatizing them head-on will not help serve the accumulated bad loans granted to these enterprises by state banks.

Therefore, China’s road to a superpower status is anything but straight and painless; in fact, Beijing will have to tackle a long list of challenges both at home and abroad. It appears that the biggest challenge for Beijing is the clash between the country’s internal backwardness and its increasing international importance.

At the same time, China’s weight in East Asia and beyond the boundaries of the particular region is rapidly increasing. Especially now, amidst the current financial turmoil that started in July 1997 and Japan is suffering from the worst post-war crisis calling into question Tokyo’s own regional leadership. For all that, it would not be accurate to say that Beijing is to displace Tokyo from the leading position - or not just yet. At the very moment, Japan may not have the "muscle" to lead the region out of the turmoil, but there are few indications that China can do that instead.

Indeed, China’s role in containing the current economic and financial crisis in the region has been somewhat neglected. So far, the high growth rates of its economy and the stability of the renminbi have turned out to be positive factors in avoiding even worse consequences of the 1997 collapse. This role may yet to be affirmed and expected.

As far as China’s export growth remains high, the speculation on a devaluation of the renminbi seem to be irrelevant, but what could happen if, as some voices are suggesting, Chinese exports slow by the end of 1998?". The answer to this question may well be provided by developments in the months to come. On the other hand, it is clear now that the importance of China’s exports has been paid a somewhat excessive attention; China is indeed a great exporter, but its imports remain impressively high, too. Therefore, unless a fundamental crisis afflicts China, its currency does not have to depreciate at this stage.

A final note would focus on the fact that China’s opening up to the outer world since the late 1970s may well prove one of the most important events in the post-war history of the world. No doubt, this is a development that will have an impact on the entire state of international relations in the 21st century. It is up to future analysts and statesmen to evaluate the precise extent and implications of this shift in Beijing’s behaviour.

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