Rising China, grouchy partners

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China's astonishing growth rates over two decades have attracted the international spotlight. Much less attention has been paid to another remarkable feature of the Chinese economy, namely, the exceptional degree of its interdependence with other major economies. Yet, the full political implications of China’s economic rise cannot be understood without reference to this.

China’s economic development since the 1990s has followed an export-led pattern, similar to the Far East’s earlier models. When Deng Xiaoping launched China’s economic reforms in 1978, its foreign trade accounted for a mere 0.6% of world trade. By 2004, China’s share had shot up to 6.5%, making it the world’s third biggest trading country after the US and Germany. It is now set to overtake the latter.

China’s vast trade volumes and domestic market size already spell interdependence between China and its principal trading partners. This is enhanced by a unique feature of China’s recent development. To a greater extent than any of its Far Eastern neighbours, China’s export-led development has been dependent on massive overseas investment flows. By World Bank data, net FDI inflow into China was $79 billion in 2005. Some of this is believed to involve “round tripping”— or the re-routing of funds transferred overseas by Chinese individuals/firms to gain tax benefits granted to foreign investors—but the figure still dwarfs that of any other country at a similar stage of development.

It’s estimated that foreign-funded enterprises accounted for as much as 55% of China’s exports in 2003. In contrast, such businesses contributed 25% of South Korea’s manufactured exports when it was at a similar stage of development (1974-78). In the case of Taiwan province, the figure stood at only 20% in the mid-1970s. This means that foreign companies have a much greater stake in China’s economic and export performance than was the case with Asia’s other “tiger economies”. So, while Japan’s stellar export performance in the 1970s triggered lurid fantasies of a new “yellow peril” (a US bestseller even warned of the “coming war” with Japan), China’s exports have generated no such hysteria. Yet, the imbalance in US-Japan trade did not even remotely approach the $124 billion deficit registered by the US in its trade with China in 2003. The few protectionist calls against China heard in the US originate mainly from smaller firms, not MNCs.

The new role conferred on China by its rising profile in world trade became evident during the Asian financial crisis of 1997-98, when affected southeast Asian countries feared that their efforts to stimulate exports through devaluation might be thwarted by an offsetting devaluation of the Chinese currency. Beijing set these fears at rest. China’s decision to maintain exchange rate stability was hailed as a constructive contribution to withstanding the crisis. Of late, the exchange rate of the Chinese yuan has become a prominent item on the US-China diplomatic agenda. Facing huge deficits in the bilateral trade balance, Washington has been pressing Beijing to revalue its currency in order to narrow the deficit.

During the early years of its reforms, China was heavily dependent on the West for investment inflows and export markets. After the Chinese economy took off, the initial one-way dependence was transformed into mutual interdependence. China’s dependence on western markets came to be matched by the importance of its own domestic market for other trading nations. China’s success in attracting foreign investment meant that MNCs developed huge stakes in the Chinese economy. Indeed, China’s economic relations with the West are marked by rivalry, but these are now played out within parameters set by interdependence.

The big question is whether economic interdependence exercises a similar moderating influence on political conflicts. A feature of the current pattern of globalisation is that the largest trade and investment flows occur between major powers, in contrast to the colonial period pattern, with flows occurring mainly between major powers and their respective colonies. As a hypothesis, it may be postulated that the new pattern of globalisation tends to exercise a generally benign influence in relations between economically interdependent major powers.

Does the evidence support this hypothesis in China’s case? Many of China’s leading economic partners are also its principal political adversaries—notably, the US, Japan and Taiwan. The evidence suggests that the new economic interdependence has, indeed, helped to moderate tensions, but not—at least yet—to resolve basic political differences or reverse the overall trend of bilateral relations. Sino-US relations have improved and areas of constructive engagement have expanded. In areas like human rights, economic considerations have contributed to softening the US stand. However, Sino-US ties continue to be conditioned by an underlying long-term strategic competition. Differences persist over defence issues, including US military exports to Taiwan and its alliance with Japan. Similarly, economic considerations have soothed some irritants in Sino-Japanese relations, but Japan’s military role continues to arouse Chinese suspicions. In Taiwan, economic realities have helped contain separatism, but a resolution of the problem is not yet in sight. Interdependence helps, but only just.