China and shared regional prosperity: five risk factors

The sheer scale of China’s rise leaves no doubt about its importance to shared regional stability and prosperity

While stories of China’s burgeoning economy abound, so do concerns regarding risks with the potential to derail its growth story. China faces five highly intertwined domestic and external risk factors. Thus when engaging China we must pay close attention to how its domestic risks shape its external policy.

First, regarding short-term domestic instability, the Chinese Communist Party’s (CCP) legitimacy lies in its ability to continue to foster economic growth and improve living standards. But the days of 10 per cent growth appear to be over. Facing widespread bad loans, questionable shadow banking practices, and rapidly growing income inequality, Chinese Premier Li Keqiang has been promoting a retreat from economic stimulus, deleveraging the financial sector, and structural reform to move towards more sustainable development. Forecasters now predict China’s growth will settle at around 7 per cent. Simultaneously, China’s new leaders must also deal with corruption and environmental challenges. China’s current situation requires a fine balancing act between managing people’s expectations for a good life now and the need to implement structural reforms to prevent future crises.

Chinese citizens are increasing populist pressures on the government by expressing their political frustrations online. The risk here is that President Xi Jinping will be tempted to use diversionary tactics, including nationalism vis-à-vis external hostile forces (including Japan and the US), to distract from the CCP’s governance shortcomings.

Second, China faces several long-term structural challenges that could affect its economic and political stability. China’s newly prosperous and educated middle class are likely to have greater expectations of the government and a greater capacity to exert pressure. For the sake of long-term internal stability, the CCP must proactively explore ways to give citizens legitimate channels to vent political frustrations rather than unauthorised protests or anonymous posts on Weibo, the Chinese version of Twitter. Additionally, reforming the hukou household registration system — which restricts citizens of rural domiciles from sharing in urban economic benefits — is crucial to addressing rising income inequality, but to be successful it must be implemented in tandem with improved rural migrant access to employment, housing, social welfare, and education. China also faces looming demographic challenges that are worsened by the fact that it will be the first country to get old before it gets rich. Hollowing out is also a risk to China’s growth given that the rising cost of labour is leading companies to relocate factories outside of China. Moreover, corruption and political problems are prompting China’s rich to emigrate in increasing numbers. China will need to break through the middle-income trap by moving up the production chain while also staving off a brain drain. Finally, the education system, which is characterised by the institutionalisation of patriotic education and a lack of academic freedom, means that China risks not creating the human capital necessary to deal with future challenges.

Third is issues the CCP has defined as ‘core interests’. This includes disputes regarding Taiwan, Tibet, and Xinjiang and in recent years has sometimes been broadened to include the Senkaku Islands, South China Sea territories, and the border conflict with India. The ‘core interest’ label positions an issue as crucial to the CCP’s pledge to protect China from repeating its past ‘national humiliation’ at the hands of foreign powers and as such constrains the CCP’s policy options. It is therefore crucial that other countries in the region be aware of tripwires that may force the CCP into a corner where it must take an excessively tough stance for the sake of its political legitimacy. At the same time, the region must work with China to encourage it to transcend its current domestic political dynamic within which nationalism exerts tremendous pressure on policy concerning what China considers to be its core interests.

Fourth, the US–China relationship is of utmost importance to the region. Relations between the two countries appear to be heading in a relatively positive direction, although considerable frustration remains within the US Congress due to the lack of concrete results. President Obama and President Xi’s recent California summit and the Strategic and Economic Dialogue that took place a month later saw the two countries discuss practical cooperation on issues such as the Korean Peninsula, cyber security, and a possible bilateral investment treaty. However, if not managed carefully, these issues could potentially become spoilers and undo the good work.

China has begun framing its relationship with the United States as a new type of great power relations in tandem with Xi’s call for a ‘Chinese dream’ and ‘national rejuvenation’. The United States, however, is reluctant to go along with such lofty rhetoric, which may lead to an implicit acceptance of China’s conception of its core interests, and instead appears intent on adopting a pragmatic approach to cooperation. This can be seen as a double-edged sword. If referring to great power relations helps to satisfy Chinese nationalists and leads China to become a responsible regional stakeholder, it is a positive outcome. On the other hand, if such nationalistic politicking leads China to adopt an aggressive posture, pursue hegemonic actions, use force to settle disputes, and shun international norms, regional stability will be greatly undermined.

North Korea policy is also a prickly issue. China is seen as a key influence on North Korea. While Obama and Xi agreed in California that North Korea cannot be recognised as a nuclear power, and South Korean President Park Geun-hye’s trip to Beijing has seen a renewed improvement in ROK–China relations, questions remain regarding how far China is willing and able to pressure North Korea to commit to meaningful negotiations and ultimately to denuclearisation. The extent to which a coordinated US–ROK–Japan–China approach toward North Korea is possible will be one measure of US-China relations and the potential for substantive big power cooperation.

Finally, Japan–China relations have deteriorated to new postwar lows, especially due to tensions surrounding the Senkaku Islands issue. Under the current circumstances, Japan-China relations can be seen as the most immediate risk factor with the potential to seriously jeopardise regional stability. From the Japanese standpoint, there appears to be no room for a compromise on the Senkakus given the clear historical records. At the same time, given the high level of nationalism that has been associated with the issue in China, the CCP will aim to avoid any impression of a compromise. With no immediate resolution in sight, the only rational move is an attempt to reduce tensions. Prime Minister Abe and President Xi need to sit down together and find the right plan to manage the issue so that it is not allowed to dominate the relationship and undermine substantive areas of cooperation. The decision by Abe to not visit Yasukuni Shrine on August 15 — the day Japan commemorates the end of World War II—will hopefully help create an opening for positive relations between the two leaders.

The Japan-China relationship is critical to both countries and the region given the two countries’ huge trade and investment flows, their economic complementarity, the interdependent nature of regional production networks, and their respective political influences. Moreover, as Abe seeks to push through the third arrow of his Abenomics program — structural reform — to revitalise Japan’s economy, and as Xi seeks to balance China’s economic deceleration and shift to a more sustainable pattern of development that still responds to public expectations to improve living standards, neither leader can afford to allow disputes to undermine economic cooperation.

A strong political commitment is needed from both countries, including the espousal of a future vision for the relationship. Public relations measures to improve citizens’ understanding of the bilateral relationship beyond the Senkaku issue and the removal of barriers to increased people-to-people exchanges are also needed. Moreover, the momentum generated by Japan’s joining the Trans-Pacific Partnership should be utilised to accelerate negotiations of trade pacts that both Japan and China are party to, namely the Regional Comprehensive Economic Partnership and the Japan-China-ROK FTA. Finally, the region stands to accrue tremendous gains by launching intensive regional energy cooperation, especially through the East Asia Summit, and Japan-China cooperation in this area is key to its success.

The intertwined nature of these five risk factors means that they cannot be addressed in isolation of one another. If the CCP focuses solely on its domestic situation and merely reacts to external events, it risks losing the opportunity to reap the benefits of economic cooperation that would in turn help it to better address its domestic risks. On the other hand, if the CCP is not attentive enough to its domestic risks, it will increasingly feel the need to resort to diversionary tactics that malign the United States and Japan, further exacerbating its external risks. It is also important for Japan and other countries in the region to take into account all of these five risk factors, including China’s domestic challenges, in formulating successful approaches to China. The manner in which China faces up to these risks — and the cooperation the region gives China in this process — will have long-lasting effects on the future of regional stability. If the region can get this tricky mix right it will cement shared prosperity for decades to come.

Hitoshi Tanaka is a senior fellow at the Japan Center for International Exchange and chairman of the Institute for International Strategy at the Japan Research Institute, Ltd. He previously served as Japan’s deputy minister for foreign affairs.This article is an extract from East Asia Insights Vol. 8 No. 3 September 2013