Prepared Statement by
John J. Tkacik, Jr.,
Research Fellow in China Policy at
The Heritage Foundation
for the
U.S.-China Economic and Security Review Commission
Hearing on
China’s Growth as a Regional Economic Power: Impacts and Implications
Thursday, December 4, 2003
Strategic Risks for East Asia in Economic Integration with China
Introduction
China’s growing economic clout in the Asia Pacific Region, and even farther abroad, in Russia, Central Asia and the Middle East, even in the European Union, is already translating into growing influence on the national security considerations of China’s neighbors and major trading partners.
As China’s economy continues to expand at 7% to 13% annually, we can expect China’s to be the second largest in the world, overtaking Japan’s economy in purchasing power parity terms well within the next decade -- particularly if Japan growth remains in the doldrums.
Foreign direct investment in China -- in galactic proportions -- has turned the mainland into the “Workshop to the World”. An inexhaustible reservoir of cheap labor, a unified commercial structure, an burgeoning domestic demand makes China’s export-oriented manufacturing sector dominant in Asia. But more ominously, China’s internal fiscal and taxation regimes have encouraged foreign direct investment to move into capital-intensive, heavy industry and advanced technology at an alarming pace. Not only is China now the “Workshop to the World”, it is fast becoming “Workshop of the World.” China now produces aluminum engine blocks for automobiles assembled in the United States, it produces raw plastic resins for mid-stream production lines in the U.S. It produces glass substrate for flat-panel video displays. It is the world’s largest consumer of steel, copper and zinc, and the largest producer of steel, aluminum and zinc. China
this year surpassed Japan as the world’s second largest petroleum user after the U.S.
China is now on the verge of developing a world-class semiconductor manufacturing industry, complete with a world-class semiconductor design infrastructure.
In short, China is a growing global economic power. And this is a development that is unsettling, even alarming, to China’s neighbors in Asia, as well as a fact of life in the strategic and economic calculus of China’s major trading partners outside the Asia-Pacific Region.
China’s Strategy before September 11 . . . and after
Throughout the 1990s, China’s leadership tended to confront its neighbors in the Asia-Pacific region with its military power. In 1995, Chinese missile tests in the Taiwan Strait halted commercial shipping in the Strait for over one week, and in 1996 China shot at least three short-range ballistic missiles into Taiwanese waters cutting off all maritime traffic in the Taiwan Strait for two weeks. In the mid-1990s China’s navy aggressively expanded its presence in the South China Sea building permanent structures on submerged coral banks -- as is allowed by the UN Convention on the Law of the Sea (UNCLOS) in economic exclusion zones -- in waters also claimed by the Philippines. China’s harassment of U.S. reconnaissance aircraft and ships in international waters also became increasingly aggressive.
Central Asia
In Central Asia, China strong-armed three of its neighbors, Kazakhstan, Kyrgyzstan and Tajikistan into border talks, then into border demilitarization talks, and finally into negotiations on a formal security treaty which included Russia. Later Uzbekistan joined the new alliance, called the “Shanghai Cooperation Organization”, but it was clear that none of early three Central Asian states felt free to rebuff China’s “invitation”.
ASEAN
ASEAN states seemed intimidated by China’s military and economic presence, and especially by the ability of China to attract foreign direct investment away from Southeast Asia to China.
Since September 11, 2001, however, China has changed its approach. Rather than intimidate its neighbors, it has assiduously pursued a strategy of transforming its economic clout into political influence. In November, 2001, China made a bold proposal to the Association of South East Asian Nations (ASEAN) to begin negotiations over following decade towards forming the largest free trade zone in the world with a population of around 1.7 billion. The agreement with China form a free-trade area in goods, services and investment by 2010, with four weaker Southeast Asian countries given until 2015 to meet targets, and the pact would take effect within a target of three years from the formal launch of the pact on July 1, 2003.
At the time several ASEAN nations were alarmed and even the normally sedate ASEAN Secretary General Rodolfo Severino warned that ASEAN itself was not yet a unified market, and implied that it was too soon to leap into a trade pact with China. But ASEAN acquiesced out of fear that to balk might alienate China. China’s strategy was sophisticated. It encouraged manufacturing investment to flee ASEAN to locate nearer the larger China market.
In a bid to weaken ASEAN resistance, China offered an “early harvest” proposal that would give ASEAN agricultural products duty-free access to the China market for three years, before China would require free-trade access for all goods with ASEAN. The result was that ASEAN members without a strong agricultural export sector would lose out, while those that did export farm goods and secondary products, like Malaysia, Thailand and Indonesia, would be inclined to move ahead. In effect, China’s divide-and-conquer strategy with ASEAN has worked. One Japanese analyst concluded that "China . . . hopes to form at some point a counter power comparable to the U.S. and Europe by unifying Asian countries" under its leadership.
At the ASEAN foreign ministers' meeting in Phnom Penh in June, 2003, China followed-up this trade initiative with a proposal for a broad-ranging "Strategic Partnership" with ASEAN that included political cooperation. A Senior ASEAN official described the proposal as "an ambitious document whose sub-text is to keep the Americans and the Japanese at arm's length from ASEAN, or at least to give China a special relationship with ASEAN." Other ASEAN diplomats wondered how the United States would react, but as far as I can see, Washington has greeted the prospect with equanimity. In July 2001, China signed on to ASEAN’s “Treaty of Amity”, a disputes procedure established by the Association of Southeast Asian Nations (ASEAN) in 1976, which commits Beijing to use peaceful means to resolve territorial conflicts. In adopting the treaty, China has agreed not to "participate in any activity which shall constitute a threat to the political and economic stability, sovereignty, or territorial integrity" of other signatory states. The intent was to ease ASEAN fears that China has territorial designs on the South China Sea claims of littoral ASEAN members. But a few ASEAN states, particularly the Philippines, continue to be highly suspicious of China’s intentions, and Beijing is subtly pressuring Manila by continuing its persistent “oceanographic research” in Philippine waters in violation of its security commitments
China’s strategy is paying off. China's total trade with ASEAN in 2002 was about $55 billion, or about half the value of China's trade with the U.S, and Chinese imports from ASEAN grew 60% in the first four months of 2003. China's exports to ASEAN grew 29% in the same period, but since then, according to a Thai official quoted in the Wall Street Journal, "China is dumping more of its exports into ASEAN and it is worrisome."
The net result is quite predictable. The ASEAN-China free trade pact will mean that Chinese manufacturers will break into Southeast Asian manufactured goods markets and ASEAN will be reduced to providing a stable supply of commodities and raw materials to China’s economy.
In the end, one can foresee that manufacturing in ASEAN will be swamped by duty-free competition from China, and Southeast Asian industrial investment will be relocated to China. FDI flows to economies in the Asia–Pacific region declined 24 percent from 2000 to 2001. Trade suffered similarly, with growth in merchandise trade falling to an estimated 2 percent in 2001 from 12 percent in 2000. But in 2001 and 2002, China took in $100 billion in foreign direct investment, making it the number one Asian destination for all FDI—with investment levels up 16.89 percent in the first six months of 2002 alone. An example of the social and labor impact in Southeast Asia can be seen in Malaysia where Unico, a Malaysian firm that had been providing computer motherboards to chip giant Intel Corp, lost its Intel business when a Chinese rival grabbed the contract by offering to do the job for about half the price. At a stroke, half of Unico's 1,600 workforce was laid off. It is a story repeated weekly in the Malaysian press.
In the “zero-sum game” of FDI, China is sucking the oxygen out of the markets in Asia, and elsewhere for that matter. The result, in the words of one Hong Kong analyst, is that competition from China will reduce Southeast Asia’s economic growth rate.
Even the New York Times sees China’s economic presence “chipping away at the United States’ position as the region’s economic engine,” beginning “an inescapable process of China replacing the United States as the dominant power in Asia” and becoming “already an economic and political threat to Japan.” The Times quotes one analyst as explaining that “the export story for South Korea and Taiwan may not be so good because the components and parts factories will shift to China…. [A]nything with volume is likely to end up in China.” And there is a pervasive fear that Southeast Asian countries will be relegated to the role of supplier of food and raw materials to China in exchange for cheap manufactured goods that will, in turn, harm their own businesses.
The Affect of China’s Trade and Investment Growth on Asia
These broader trends are already having their affect on labor patterns and standards of living conditions, not only in Southeast Asia, but in Japan, Taiwan, and in the Western Hemisphere as well. Taiwan government officials warn of the “hollowing out” of Taiwan’s core industries as a result of an across-the-board migration of Taiwan’s production lines to China. Trade patterns indicate that this same phenomenon has been a major factor in the persistent economic stagnation in Japan.
As late as July 2002, several major Japanese firms announced they would close production lines in Southeast Asia to cut costs and consolidate their assembly operations in China. NEC Corp. will close a personal computer line in Malaysia and move it to China. Seiko Epson Corp. will close a scanner production line in Singapore and transfer some production to China. Minolta will close a camera assembly plant in Malaysia and move the equipment to a factory in Shanghai. And the world’s largest miniature ball bearing maker, Minebea Ltd., will relocate a measuring equipment line from Singapore to China. New statistics from Singapore show that the country lost more than 42,000 jobs in the past five years, most of them to China.
Some see China’s economic power as the beginning of “an inescapable process of China replacing the United States as the dominant power in Asia.” Others call China “already an economic and political threat to Japan.” Indonesia is seeking a $9 billion Chinese government liquid natural gas contract to power the industries of southern China. As the New York Times put it, “China—a hungry importer, a siphon of other nations’ foreign investment and a surging exporter of cheap manufactured goods—is forcing its Asian neighbors to adjust.”
Advanced Technology Investment and Trade
Ironically, the three countries with the most direct concerns about China’s military modernization—Taiwan, the United States, and Japan—also have extensive direct FDI exposure in China’s advanced technology industries which support modernization of China’s People’s Liberation Army.
By the end of 2001, Taiwan economic ministry officials say, Taiwan firms had invested an estimated cumulative US$70 billion in China, while Taiwan’s Central Bank of China believes over US$100 billion in Taiwan-controlled assets are in China. Chinese figures are a bit more modest, showing a total of US$29.134 billion. Chinese government figures reflect that 2001 was the biggest year for Taiwan investments since 1995, with US$2.979 billion in Taiwan direct investment.
But there has been a major change in Taiwan’s investment patterns. No longer is the bulk of Taiwan money coming from small and mid-sized manufacturing operations in the low-tech sector. Instead, it is coming from Taiwan’s largest firms. In the first seven months of 2002, Taiwan firms invested US$1.94 billion in China, and 51.9 percent of that was new investment in the electronics sector alone.
The United States is a somewhat smaller investor in China than is Taiwan, but of higher quality. By 2000, American firms had invested a total of US$9.58 billion in China, with over a third in high-tech manufacturing. In 2000 alone, U.S. direct investment outflow to China and Hong Kong hit a record high of US$4.4 billion. In 2003, according to Assistant Secretary of State James Kelly, U.S. direct investment in China was up to $5 billion.
Japan investment in China is also quite substantial, with over US$1.5 billion in FDI estimated in the first half of 2001, 50 percent over the 2000 figure of US$995 million, which itself was 32.5 percent over the previous year. Although the textile industry in China had attracted the bulk of Japanese FDI in the 1990s, since 1998 a third to a half of Japan’s China-bound FDI was in the high-tech sector, particularly in electrical machinery and electronics. By the end of 2002, Japanese unemployment was at an all time high of 5.5%, and even advanced production facilities like Minolta’s and Olympus’s camera factories near Tokyo were moving Japanese plants to China, leaving their small and medium sized suppliers in Japan high and dry.
This phenomenon is even starker for Taiwan companies, which fill between 21 percent and 24 percent of all export orders from production lines in China. Indeed, Taiwan exports to China have risen from 18 percent of total exports in 1999 to nearly 23 percent of total exports in 2002, with 31 percent of exports to China being “electrical equipment and components.” Over 70 percent of the exports appear to be destined for export processing. Earlier statistics indicate that Taiwan firms also account for 73 percent of China’s entire information technology (IT) product output.
The significance of these trade patterns is that China’s advanced-technology (AT) infrastructure is being built largely with foreign direct investment. Although FIE production lines heretofore had been designed to assemble imported AT components into electronic and IT hardware and appliances for subsequent export, foreign suppliers are now setting up the actual component production lines in China to be closer to their assembly lines and the assembly plants of other AT product customers.
Semiconductor technology is a prime example of this phenomenon. Already, Motorola manufactures mobile-phone specific integrated circuits—particularly global positioning ICs—at its MOS-17 waferfab in Tianjin. The MOS-17 facility includes full-up R&D, design, and manufacturing centers and will employ a total of 2,400 workers by the time it begins operation in 2002. By 2001, Motorola had 10,000 employees in China, including 1,500 researchers at the company’s 18 labs. With the MOS-17 fab, Motorola’s total investment in China was about $3.4 billion in 2002, making it the largest foreign investor in China. But Motorola is now in the process of shedding all its production facilities, and has been obliged to sell off its Tianjin plant to a Chinese-owned chip fab for 20% of its value.
NEC Corp. of Japan has begun to produce 128-Mbit DRAMs at 0.25-micron linewidths (the industry standard) at its NEC Shanghai Huahong fab.
The Motorola and NEC investments have prompted Taiwan’s top waferfabs—Taiwan Semiconductor (TSMC) and United Microelectronics (UMC)—to petition the Taipei government to permit them to transfer existing waferfabs to China. While Taipei has agreed in principle to the TSMC and UMC requests, it has conditioned its approval on the assurances that the Taiwan waferfabs will be replaced in Taiwan by more advanced facilities. As yet, the Taipei government has not issued formal rules governing the transfer of semiconductor facilities to China.
A migration of Taiwan's "crown jewel" technologies to China via Taiwan entrepreneurial exiles has alarmed Taipei's government. In a top secret report entitled, "An Analysis on how the Chinese Communist Party Attracts Taiwanese High Tech Investment for the Suzhou Industrial Park," Taiwan's intelligence agency reported in July 2001, that the Chinese authorities have a blueprint to actively develop semiconductor and high-tech industry "clusters" which include the entire spectrum of each industry. The result, the report said, was that China has effectively attracted the key sectors of Taiwan's computer industry, from downstream component makers like computer motherboard and monitor producers to PC cases and mouse makers. The report suggested that the Taiwan-invested high-tech sector would be a virtual "puppet" of Beijing, and recommended that the Taiwan government adopt policies to curb high-tech investment in China.y Indeed, the one high-tech area in China in which Taiwan's government still prohibits local investors from investing is semiconductor fabrication, but that ban, too, appears to be eroding.
Again, the impact of the loss of Taiwan manufacturing jobs to China is having a profound effect on labor and social stability in Taiwan. Unemployment is down from the all time highs in 2002 of over 6%, but is cannot seem to get below 5.5% despite the resurgence of economic growth in 2003. Thousands of white collar jobs at Taiwan companies are being relocated to China, and one estimate has over 300,000 Taiwan passport holders residing in China with over a million in China at any one time.
Russia
There are mirror phenomena in Central Asia and Russia, which I have red about only anecdotally. Kazakhstan’s largest city, Almaty, reportedly has a Chinese suburb of nearly 100,000. In 2002, Russian Defense Minister Ivanov said he had no concerns about the number of Chinese workers in the Russian Far East, which “numbered between 200,000 and 5 million.” Since there are only 8 million Russians living in the Russian Far East, Minister Ivanov probably protested to little to avoid a diplomatic row with China, his ministry’s biggest customer for advanced weaponry. China has successfully leveraged its large population presence into geopolitical influence. In May 2002, Beijing successfully pressured the Kazakh government to withdraw an offer of basing support to U.S. forces supporting the Afghanistan campaign.
South Korea
South Korea is also a major investor in China, with over 56% of all ROK outbound direct investment going to China. Seoul also sees China as a potential brake on North Korean aggressiveness, and this makes the South Korean government solicitous of Chinese sensitivities across the board, from how the ROK handles the North Korean nuclear crisis, to Taiwan.
Petroleum, Natural Gas and Arms
China’s appetite for petroleum and natural gas has also made it an important customer for Saudi Arabian oil and Australian natural gas. It is in a position to leverage its political influence on Central Asian and Russian energy decisions. Last year, China chose Australia over Qatar and Indonesia to supply it with 25 billion Australian dollars worth of gas over 25 years. And last month, the state-owned China National Offshore Oil Company signed an agreement outlining plans to sell Australian natural gas in China and to take an unspecified stake in the Northwest Shelf project. Chinese President Hu Jintao’s October 2003 visit to Australia highlighted the growing Australia-China trade relationship and even had political commentators in Canberra pondering how Australia would react if some crisis in the region obliged it to chose between the United States and China.
The European Union is even reassessing its view of China. Just this week, EU Trade Commissioner Pascal Lamy said he was willing to "reconsider" the European Union's embargo on arms sales to China. His statement backs up comments this week by German Chancellor Gerhard Schroeder to Chinese Premier Wen Jiabao that China would be an excellent market for European military equipment. The EU’s embargo was imposed after Beijing's crackdown on pro-democracy protesters in Tiananmen Square in 1989, and China told the EU in October that it wants the ban lifted.
Conclusion
This is hardly a comprehensive review of China’s politico-economic influence in the Asia Pacific region, but it is enough to raise alarums. While Washington is preoccupied with the War on Terror, the occupation of Iraq, the North Korean nuclear crisis, and dozens of lesser brushfires, China is patiently and systematically amassing a geopolitical presence of superpower proportions in Asia. Washington must start to take China seriously as a potential great power competitor in the region.