China’s influence gap

After delivering his keynote at the Shangri-La Dialogue, the annual meeting of regional defense ministers in Singapore on Saturday, U.S. Secretary of Defense Robert Gates took questions. But unlike in previous years, the toughest challenge didn't come from a Chinese military officer. Kishore Mahbubani, a former Singaporean ambassador to the U.S. and a prominent advocate of the view that America should accept that its era of leadership in Asia will soon be over, asked how America could maintain its position of strategic primacy in Asia in light of China's rise and America's relative economic decline.

Secretary Gates didn't give any ground, challenging Mr. Mahbubani to a $100 bet that in five or 10 years, America will be in the same position as it is now. An even bigger contrast from previous years is that a growing number of Chinese officials seem to agree with him.

In competitive terms, no one disputes that China's economic rise necessarily implies America's relative decline. But Beijing is finding that translating its economic size into regional strategic and diplomatic leverage is more difficult than it first appeared.

Many of China's political officials, military brass and strategists, who were well represented at the conference, naturally assume that its growing economic size and weight in the region should give it proportionate influence and leverage over other Asian capitals. Speculation about the opening of a "window of opportunity" to extend China's relative influence became feverish from mid-2009 to mid-2010. Chinese officials were genuinely surprised and subsequently incensed when smaller Southeast Asian nations dared to defy China by openly encouraging American involvement in the South China Sea dispute throughout 2010.

Moreover, Beijing is uncomfortably confronting the reality that almost all regional countries choose not only to hedge with America, but are actively maneuvering to perpetuate American strategic dominance in Asia. As Secretary Gates noted in his keynote address, regional military-to-military relationships with Washington are actually strengthening, even as economic power shifts from West to East.

Given that China is Asia's largest economy, this is an apparent paradox. But the key to understanding the limitations of the Chinese capacity to translate economic size into proportionate leverage lies in the operation of the Chinese political economy.

Intuitively, China appears to have a powerful economic weapon with which to maximize strategic and diplomatic leverage. Trade can be used as a carrot or a stick to bring neighboring countries into its orbit. For instance, China is now the most important trading partner for major economies countries such as Japan and South Korea.

The problem for Chinese leverage is that at least half, and perhaps as much as two-thirds, of its trade with East and Southeast Asia is "processing trade." About 75% of intermediate goods imported to China come from the rest of Asia and about 60% of the finished products go to non-Asian OECD countries. Reflecting this reality, most of the terms in the dozens of regional Free Trade Agreements tend to be about streamlining processing trade.

China could try to get its way by imposing selective trading bans on major firms or even individual countries. But if it did, production chains would be disrupted at great cost to all parties, including China. Asian firms would eventually find other manufacturing avenues, even if it were costly and time-consuming to do so. Besides, China needs the technology transfer that comes with this trade, and politically can't afford to do significant damage to its export manufacturing sector, which employs 150-200 million workers.

The other way China might use trade as a weapon would be to selectively withdraw access to the Chinese consumer. But once again, the capacity to inflict economic pain on selective firms and countries is not sufficient to compel key capitals to change their strategic alignment.

Raw numbers can be deceptive. The Chinese economy constitutes a large component of global economic growth, but it is not so important as a driver of global growth. This is due to the fact that 50% to 60% of GDP growth is driven by domestically funded fixed investment.

China's total domestically funded fixed investment amounts to about $2.5 trillion each year, as compared to $105 billion of foreign direct investment. This investment-driven model means that its domestic consumption is suppressed. Until China becomes the dominant center for domestic consumption in the region and becomes the end consumer of manufactured goods, which is decades away, its impact as a driver of growth will be concentrated in the commodity markets.

Then there is the matter of actual access. Since more than three-quarters of all bank loans go to state-owned enterprises, and the most important and lucrative sectors are reserved for SOEs, few foreign firms currently enjoy significant access to the most profitable Chinese markets. There is a political consensus in Beijing that policies protecting SOEs should remain. This further restricts Beijing's ability to use access to markets as a point of leverage.

To be sure, China's relatively closed "state-capitalist" political economy puts enormous resources into the hands of the state. A rich state can fund rapid increases in defense spending. But it lacks the leverage and influence that comes from having an open political economy. Needing to overwhelm with pure muscle and size, Beijing's capacity to translate its economic footprint into political and diplomatic leverage remains extremely inefficient.

In 2010, Beijing learned that bluster and bullying creates alarm and even fear, but not necessarily influence. So it's hardly surprising that in 2011, its officials have reverted to platitudes about China's peaceful development and harmonious world view, as Minister of National Defense Gen. Liang Guanglie did at the conference. This is the increasingly unconvincing diplomatic default setting of an economic giant that is unable to exercise proportionate strategic leverage in its own region.

Dr John Lee is a Research Fellow at The Centre for Independent Studies in Sydney and the Hudson Institute in Washington. He was a member of the Australian non-governmental delegation at the Shangri-La Dialogue.