China’s vice president, Xi Jinping, is set to make a hugely important visit to the US next week, prior to succeeding President Hu Jintao as China’s next president later this year.

The visit will set the stage for interaction between the next generation of Chinese leaders and American political leadership and help to shape how the most important bilateral relationship in the world will be managed over the medium-term future.

In recent times, the political-security dimension of the Sino-American relationship has received increasing attention, as the US ‘pivots’ toward Asia. But core and immediate challenges concern the economic relationship and how rapid change in the Chinese economy plays into US and global interests. These matters will be at the forefront of Mr Xi’s meetings when he visits Washington.

In a recent interview in the Wall Street Journal Nick Lardy argues that ‘if China does not accelerate the pace of reforms that support rebalancing, when global growth resumes a more normal pace, China’s external surplus likely would expand again. That would mean that China again would be subtracting from economic growth in the rest of the world, including the United States. That would make it more difficult for the United States to reduce its budget deficit to put its government debt on a more sustainable path’.

Lardy’s lead essay this week reflects the view set out in his new book that correcting the numerous imbalances is necessary to propel China toward a new and sustainable growth path.

Among the problems, Lardy says, are: a low share of private consumption expenditure and a super-elevated share of investment in GDP; an outsized manufacturing sector and a diminutive service sector; an unprecedentedly large hoard of official holdings of foreign exchange; and an increasingly high and probably unsustainable rate of investment in residential property. Mitigating these imbalances will require fundamental market-oriented reforms. The pace of reform will need to be accelerated to achieve sustainable, domestically driven growth and harmonious relationships in the international economy, notably with the United States.

Chinese economists, such as Yiping Huang at Peking University, have made the same point about the distortions in Chinese markets that need to be addressed to correct imbalances in the economy.

Lardy worries about the tardy pace of reform in China. ‘Market-oriented interest rate liberalisation, eliminating the under-pricing of energy and other factor inputs used predominantly in manufacturing, greater flexibility of the exchange rate and an even more rapid expansion of the social safety net are essential to moving China onto a consumption-driven growth path. Many of these reforms have been on the agenda for a decade or more’, he says, ‘yet with the exception of increased social expenditures, progress has been painfully slow’.

According to Lardy, the explanation is that financial repression, the undervaluation of the currency, and factor price distortions advantage some sectors and regions of China at the expense of others. The benefits of unbalanced growth flow to export- and import-competing industries (which enjoy elevated profits at the expense of firms in the service sector), coastal provinces (which have enjoyed supercharged economic growth at the expense of inland regions), the real estate and construction industries (which have benefitted from interest rate policies that have made residential property a preferred asset class), and China’s banks (which enjoy lofty profits that come with the high spread between deposit and lending rates set by the central bank) who have acquired disproportionate influence over economic policy. And to date they have been able to block much-needed policy reforms. These reforms are necessary if China is to move toward a more balanced, sustainable growth path.

Lardy also argues that there are immediate dangers to strong growth in China from excessive investment in housing and real estate. The share of residential investment in GDP has doubled to more than 10 per cent between 2003 and 2010, a share far higher than that in countries with comparable per capita incomes. This was induced, Lardy argues, in part by households channelling their savings into housing in the face of negative real deposit rates in the state-owned banking system.

While Huang sees less immediate risk of collapse in the housing market, residential housing has become the single most important driver of China’s economic growth since the middle of the last decade. Lardy is right in observing that this cannot last indefinitely, although how long it lasts is a very important question.

Peter Drysdale is Editor of the East Asia Forum.

1. Sustaining economic growth in China
2. Reform in China: Experience with economic system reform
3. Chinese economic risks

The whirlwind visit of President Barack Obama to Australia on the way to the East Asia Summit in Indonesia last November, many believe, forever changed the Asia Pacific strategic landscape with a re-assertion of American primacy and power in Asia.

What was the thinking behind the moves that Obama announced in Canberra and how will it shape Southeast Asia’s strategic future?

American power is already well entrenched in Asia and the Pacific. A modest elevation of American troop presence on rotation and training in northern Australia — one concrete outcome of the visit — will have at most a marginal impact on the immediate strategic landscape. But Mr Obama’s visit, and in particular his declaration to Australia’s Parliament that America is ‘all in’ in Asia and the Pacific, changed the tone of the contest for influence between America and China in the region and cast it in more confrontational terms.

In this week’s lead Geoffrey Wade suggests that ‘the Darwin deployment is only one part of a much larger regional strategy, placing US forces far enough from Chinese missiles to be comfortable, but still sufficiently near to maritime Southeast Asian allies to swiftly engage if necessary. The proposed stationing of the US Navy’s newest littoral combat ships in Singapore and the growing American naval and air force cooperation with Indonesia serve a similar function’.

Wade sees these moves as the beginning of a major increment to US-led East Asian security architecture, involving the creation of a Southeast sector to the ‘Offshore Asia’ security zone. He says that the Northeast American security zone is already entrenched, with US bases and facilities in mainland Japan, Okinawa, South Korea and Guam being equipped with over 80,000 service personnel and some of the world’s most advanced defence hardware. The concept of a maritime security umbrella in the Southeast sector of ‘Offshore Asia’ (including the maritime ASEAN states, Australia, New Zealand, Papua New Guinea and some of the Pacific states) is now seen in Washington as key to maintaining a balance of power in East Asia, and achieving the US’s stated aim of preventing the emergence of a regional hegemon.

It might seem puzzling that the US would seek to create a security shield just for ‘Offshore Asia’ — the maritime Southeast Asian states and Australasia. One rationale, according to Wade, is that sea lanes in this region are vital to East Asian economic security, a critical choke point in the flow of Middle Eastern oil and Australian resources to Japan, Korea, and also to China. Maritime routes need to be kept open, ‘especially while the South China Sea disputes continues to fester and demand attention’. More straightforwardly, Wade claims, this new strategy is built on the reality that the US and its allies currently have overwhelming superiority in terms of maritime power. The US Pacific Fleet alone comprises 180 ships, nearly 2000 aircraft and 125,000 service personnel. If the US is to maintain influence and allies in East Asia then it needs to provide these countries with some persuasive evidence of its defence commitment and capacities. The ‘Offshore Asia’ security shield — utilising US ‘Air-Sea Battle’ forces — is a low-cost posture that might convince.

There is related hype among the region’s security community about Australia’s integration into a forward American military hub in Southeast Asia. It is, for the moment, just that: hype and hyperbole. That the Australian base has the advantage of having direct access to the Indian Ocean and, therefore, together with the substantial US naval, air and communications facilities in Diego Garcia, provides the US and its allies with unrivalled access to, and surveillance of, Indian Ocean maritime routes is one dimension of this hype. The reports that B-52 long-range strategic bombers, F/A-18 fighters, C-17 transport aircraft and aerial refuelling aircraft will be stationed at the Royal Australian Air Force Base at Tindal, about 320 kilometres southeast of Darwin is another. At another level altogether are reports suggesting that as part of the increased collaboration, Australia is preparing to purchase or lease Virginia-class nuclear submarines from the US. The antidote to this hype is to take a Bex and have a good lie down. Dreams for the so-called American pivot towards Asia need to be based on firmer fiscal and political stuff.

The mainland Southeast Asian states, as Wade argues, are increasingly embedded in tighter developmental and economic relations with China. In all of that the US is a big player. This is no Chinese imperial plot, as the incautious readers of Wade might conclude: it’s simply the product of the weight of Chinese economic growth interacting with the growth and development ambitions of the Southeast Asian mainland states. It is no different in fact from what is occurring with Japan, Korea, Indonesia or for that matter Australia. In mainland Southeast Asia, it has been promoted with the help of the Asian Development Bank (driven more by Japanese than Chinese agendas), through the creation of a Greater Mekong Subregion linking China and mainland Southeast Asia through economic corridors, which include a Chinese high-speed rail network linking mainland Southeast Asian capitals directly to Yunnan.

Unravelling these economic-security interests from political-security postures is not as easy as it might seem to the economically untutored defence strategist. Put simply, in this theatre, Chinese maritime security interests are legitimately and fundamentally interwoven with East Asian and all our economic security interests.

The complexity is reflected in the caution of Indonesian Foreign Minister Marty Natalegawa about the Canberra declaration, lest ‘these developments were to provoke reaction and counter reaction … a vicious circle or tensions and mistrust or distrust’, even the ‘innocent’ Indonesian suggestion that China might well be invited to join joint exercises at the Australian base. At APEC earlier in November Indonesia’s President, Susilo Bambang Yudhoyono, observed that, while he welcomed America’s regional presence, it was no longer desirable for the region to be dominated by a sole superpower. ‘New power centres are growing rapidly and power relationships are changing and becoming fluid’, he said, calling for what he called a ‘dynamic equilibrium’.

Therein lies the crux of it. Playing one hand into ‘Offshore Asia’ security might be a reasonable first move. But it is certainly not a viable long-term security strategy. Whether that hand will serve the preservation of peace or contribute to future tensions in East Asia will assuredly depend also on whether another hand can be extended to China, one that provides reassurance of its role and interests in regional security.

Peter Drysdale is the Editor of the East Asia Forum.

1. The emergence of ‘Offshore Asia’ as a security concept
2. Southeast Asia: Patterns of security cooperation
3. ASEAN divides

In the latest episode in Pakistan’s unfolding political drama, Prime Minister Yousaf Raza Gilani appeared before the Supreme Court on Thursday over the failure to prosecute corruption charges against his political patron, President Asif Ali Zardari, who came to power after the assassination of his wife, Benazir Bhutto.

This is no simple one-plot play about a contest over political corruption between the Supreme Court and the civilian government of Pakistan. A joust between a high court and a civilian government is hardly surprising in any democracy, especially one like that of Pakistan, where both courts and civilian governments have been only precariously entrenched since the republic’s foundation after partition in 1947. The latest tensions are also fuelled by a parallel showdown between Mr Zardari’s administration and the military.

With a Senate election due on 2 March, where the ruling Pakistan People’s Party is expected to secure a comfortable majority because of its strength in the provinces, one question is whether the Court will accelerate its proceedings against Gilani and force an early general election (not due in the normal course of events for another year).

The Supreme Court today is different from the courts that validated previous military takeovers. Its Chief Justice was dismissed twice in 2007 by then President and military chief General Pervez Musharraf. He was restored to his position, in the face of a populist movement led by the country’s lawyers, civil society and broad coalitions of opposition political parties. The movement cost President Musharraf his grip on power, and paved the way for the general elections in early 2008 that brought the current government to power. But this same administration also refused to restore the Chief Justice and nearly 60 other superior court judges who had been unconstitutionally dismissed by the Musharraf regime — until it eventually relented in the face of the ‘Long March’ in March 2009, in which millions demonstrated their support for an independent judiciary. The bad feeling on all sides is palpable. Pakistan continues to be a country at war with itself.

The pressure to spill political blood is intense, but hard-headed calculation all round might yet keep malevolent inclinations in check. As Cheema says, what is significant about the memo incident is less that the Supreme Court has decided to side with the military and more that the military appears to have aligned itself with the courts. There is no easy way back to legitimacy for a military dictatorship, whatever the failings of the alternative.

As Pakistan lurches toward general elections, whenever they are held, the government is under pressure from all political quarters, including the courts. But the Supreme Court will not do itself or the nation any service if it is seen to play a direct role in the ouster of President Zardari and his government. Rather it will win credit if it ensures fair elections and adherence to constitutional norms and processes by all, including the military.

1. Pakistan’s clash of institutional authority
2. India’s approach to Pakistan: Whose side are we on?
3. Pakistan: US losing hearts and minds in the battle against terrorism

One of the more momentous changes in Asia that heralded in the New Year was the sudden death of North Korean leader, Kim Jong-il, and the succession by his son, Kim Jong-un.

Kim Jong-il’s death had long been seen by some outside observers as portent for the collapse of the North Korean regime and the announcement encouraged much comment that reflected these forebodings, including calls for calm from political leaders who should have been in the know.

Anything seemed possible.

Certainly there were anxieties about whether the assumption of the North Korean leadership by a relatively untried and youthful Kim Jong-un would be accompanied by a power struggle in the North and political instability. Cooler heads saw little immediate sign of that.

In this week’s lead Chung-in Moon and John Delury at Yonsei University urge focus on the realities that face North Korea itself and the rest of the world in dealing with the isolated state, not imagined contingencies surrounding the leadership change. Their injunction is timely. Moon was a key adviser to former South Korean President Kim Dae-jung on North Korean affairs and heavily involved in negotiations between the North and the South that saw the Sunshine policy put in place. But he is a hard-headed realist.

Delury and Moon point out that there are no signs of political ferment in North Korea. For the moment, the system is quite stable. The regime is ‘unified around the new face of North Korea, Kim Jong-un, the son of Kim Jong-il and, most importantly, the grandson of founding father Kim Il-sung. Kim Jong-un does not need charisma. In North Korea’s hierarchic ‘big leader’ suryong system, the young Kim is born to authority. His Baekdu bloodline is sufficient to endow his rule with legitimacy. And his power base is solid’. This is an hereditary system of rule as much as an authoritarian one.

Kim Jong-un’s legitimacy is secured by three inner circles. The first is the ruling family. The key sign of unity within the family is that Kim Jong-un’s aunt and her powerful husband Jang Song-taek both received promotions along with the heir-apparent at the historic Party conference last year. The second is the Korean Worker’s Party itself, which has been going through a period of resuscitation. The revitalised network of Party members — who now carry cell phones and are eager to travel abroad — see their prospects very much linked to the success of the grandson. The third is the military — the Korean People’s Army — which is the logical competitor in the power succession. But even in the army there is no sign of high-level disaffection like that seen in many Middle Eastern states. ‘The military’, Delury and Moon point out, ‘has been the primary beneficiary of the North’s ”military first politics” campaign initiated by Kim Jong-il in 1995′. The military has been co-opted through numerous incentives, and controlled through close confidants. The military has pledged loyalty to Kim Jong-un, whose highest title is Vice Chair of the Central Military Committee of the Korean Worker’s Party.

As for the 20 million or so North Koreans not in the Party, they are likely to take a wait-and-see approach to the new leadership group. Kim Jong-un bears a striking physical resemblance to his grandfather, evoking nostalgia for North Korea’s halcyon days, and people may hope his rule will see a new, better chapter for their country. Whatever the case, those who may wish to rebel have no networks or organisations through which to do so. For now, all signs confirm the state media slogans: Kim Jong-un is the ‘outstanding leader of our party, army and people’ and ‘great successor’ to his father.

In the near term, the chances of political crisis, let alone regime collapse, are remote. In the longer term, however, North Korea faces the same perennial hard choices: the dilemma, Delury and Moon call it, of mutually conflicting goals.

Pyongyang proclaims to its citizens that 2012 marks the year of North Korea’s emergence as a ‘strong and prosperous great nation’ [Gangsong Daeguk]. ‘If Kim Jong-il could claim nothing else’, say Delury and Moon, ‘he did achieve at least one thing for North Korea — the ultimate ”strength” of nuclear deterrence’.

What most outside observers of North Korean affairs miss is the importance of the goal of world standard prosperity. It was set out again post-succession in the New Year’s joint editorial in North Korea’s three main newspapers. There are unmistakable signs of a push to improve the national economy — from growing trade with and investment from China, revived plans for special economic zones and official propaganda promising to improve the people’s welfare.

The issue at stake is whether Kim Jong-un can enhance North Korea’s prosperity without undermining the source of its strength — its nuclear weapons program. ‘Comprehensive economic development will also require foreign investment, trade, and financing; all of which would require negotiation of loosening, and eventual lifting, the sanctions which surround the North Korean economy like a barbed wire fence. Getting that sanctions regime lifted will require substantive nuclear concessions on Pyongyang’s part’.

This, of course, opens opportunity for dealing between Pyongyang, Washington, Beijing and Seoul. As Delury and Moon observe, it will be in that moment, the transition from security-first to security-plus-prosperity, when the unity of the North Korean political system would come under strain. It was perhaps ever thus. ‘Elements in the military might oppose sacrificing their prize possession — nuclear weapons capability. Hardliners will argue it would be a fool’s errand to give up the ultimate weapon, leaving their country exposed to an Iraqi or Libyan fate’.

The path to getting the North over that hump needs to start now, with building constructive relationships with their new leadership, and avoiding the risk of playing into the hands of hardliners, and above all investing in the capacities now that North Koreans will need to run a prosperous and open economy and society. There are signs that this is recognised in Washington and Seoul, though unfortunately not in Canberra which had earlier played a helpful role in prosecuting just this interest — and again is positioned, because of the importance of being unimportant, to do so now.

Peter Drysdale is the Editor of the East Asia Forum.

1. North Korea’s transition: do not let contingencies distract from realities
2. North Korean quagmire a failure of analysis
3. Russia-North Korea: Denuclearisation of the Korean peninsula

As Europe continues its desperate struggle to salvage the euro and monetary union, the spotlight of regional cooperation is shifting to Asia.

In December, European leaders retro-fitted the union with fiscal disciplines which impose binding limits on national budgets and borrowing. All but Britain opted in; the UK, Prime Minister David Cameron argued, was not prepared to yield such fiscal sovereignty. Lack of fiscal integration alongside commitment to a common currency was a serious design flaw in the original European enterprise. The new fiscal disciplines will allow more room for the European Central Bank to act as lender of the last resort to European borrowers. Whether these ‘architectural’ arrangements for European cooperation will be sufficient to save the euro will finally depend, of course, on how and whether they encourage the ‘substantial’ structural reforms and adjustments necessary to restore growth momentum in the deeply indebted southern European states.

Faced with shrinking economies and rising unemployment, and lacking exchange rate flexibility to restore price competitiveness in external markets, how can the sick economies of Europe get to grow again? Without the option of deeper currency depreciation, real wage cuts and structural reform are the only way to export-oriented growth — outside the OECD economies — in emerging markets like those in Asia.

As Shinji Takagi argues, the European mess has revealed just how inept Europe’s supra-national institutions were in dealing with a regional problem of the proportion that has emerged there. Inter-governmentalism — that is, a willingness to cede position and sovereignty through decision making in the collective interest — moved centre stage as the instrument of crisis management. French President Nicolas Sarkozy and German Chancellor Angela Merkel had to call the shots for the rest of Europe. France and Germany are providing critical leadership: despite over half a century of regional institution building, the huge Brussels bureaucracy proved little more than a paper tiger. The implications for Asian regional cooperation are profound.

In Asia, a central question is whether strong growth can be maintained despite continuing weakness in the developed world. Success in avoiding that scenario also depends on whether extensive structural reform is put in place to shape the expansion of Asian investment — so that it continues to roll out in ways that ensure it is productive and that economic growth does not run into the sand.

Asia does not need a huge supra-national bureaucracy, but it does need its own measure of inter-governmental cooperation to keep growth on track. It has the architectural frameworks, in APEC and the East Asian arrangements, to give this effect — if it is so minded.

On recent evidence, emerging market economies in Asia and elsewhere might have had some reason to think that there was ‘trend decoupling’ between their growth rates and those in the old G7 economies. But events of the past six months should have dispelled that illusion, as interdependence through expectations and market sentiment, as well as more directly through trade and finance, has ensured that problems in the industrial economies wreak their havoc and uncertainty around the rest of the world. De-coupling Asia from European growth clearly has its limits.

The Asian emerging market economies are, nonetheless, in a stronger position than their industrial country partners, with demographic dividends still to reap, much lower debt ratios, and economies that enjoy the benefit of powerful ‘catch up’ to the industrial-country frontier. The potential rate of growth in emerging economies remains high because the ‘convergence gap’ — the gap between productivity levels in industrial countries and developing economies — remains large even for economies like China and India. This hasn’t changed because the rest of the world has fallen into recession.

With these assets, what’s to stop emerging economies powering the global economy from its industrial-country malaise?

Wendy Dobson in this week’s lead essay suggests that Asia’s focus should be on ‘re-balancing’ and trade liberalisation. Expectations of Asia’s role, Dobson says, are growing much faster than Asia’s capacity to meet them.

In Asia too regional architecture is required for cooperative action. And Asian regional architecture still lacks tight and effective links to emerging global architecture around the G20 process.

‘Yet with some notable exceptions’, Dobson points out, ‘Asia’s focus remains on the architecture rather than the domestic and regional economic adjustments required to sustain growth momentum in the face of potentially serious external shocks from renewed European recession and near-stagnation in the United States’. On trade liberalisation, Dobson puts faith in the recent US Trans-Pacific Partnership (TPP) initiative.

Others would prefer broader regional and continuing global efforts, given that China has not been engaged in the TPP and due to other circumstances in the international economy.

Without Chinese engagement in what is putatively Asia’s primary trade liberalisation enterprise, the TPP is unlikely to give much strength to the heart of Asian integration nor to global trade.

Peter Drysdale is Editor of the East Asia Forum

1. Will Asia step up to the global challenges of 2012?
2. Regional cooperation and national sovereignty: Asia and the euro crisis
3. The East Asia Summit and regional financial cooperation

A great deal in the international economy is riding on what happens to the Chinese economy in the new year.

 China’s 9 per cent plus growth since the global financial crisis has been a central element in Asia’s bucking the global recessionary trend. With Europe still in trouble and the United States struggling to keep recovery on track, is China too now destined for a hard economic landing?

In the first of our annual year-in-review series, Yiping Huang suggests that 2012 will not be a replay of 2009, with neither a hard landing nor a sharp rebound looking likely over the coming twelve months. GDP growth, Huang says, is likely to slow from 9.1 per cent in 2011 to 8.1 per cent in 2012 — with softer external demand and weaker residential investment — and inflation is likely to ease from 5.5 per cent to 3.2 per cent, but the outlook for China remains robust. Consumption is likely to play a greater role as household expenditure continues upward, and both monetary and fiscal policy settings should be modestly expansionary.

If Huang is right, as he usually is, this outlook for the Chinese economy is good news for the region and a boost for global recovery. Shaving 1 per cent off Chinese growth through the year would leave a strong performance in China and modest adverse impact on China’s overseas partners.

The two big risks for China are deepening recession in the industrial world economy and a disorderly correction of the housing market at home. China is suffering from a range of proximate economic problems, which have prompted fears of a hard landing. There has been a rapid increase in the number of small and medium enterprises (SMEs) declaring bankruptcy. Private lending has been drying up in some areas. In the last half of 2011 house prices were on a downward trend, with potentially significant implications for investment growth and asset quality. And, with the collapse of the real estate market, local governments are inevitably in trouble. Local government investment vehicles, with total liabilities of at least 10.7 trillion yuan (US$1.7 trillion), are finding it difficult to repay loans on schedule. In addition, the recent expansion of shadow banking transactions has opened up risks for the financial system.

With this bundle of problems, why is Huang so confident China will pull through the year so strongly? He cites three main reasons for why they are unlikely to lead to a hard landing of the Chinese economy.

First, the changes under way have been deliberately induced by policy adjustment, such as macro-policy tightening and housing investment restrictions. Some changes, such as the correction of property prices, were necessary to generate healthy development in the future. Should circumstances deteriorate sharply, the government will be able to reverse the policies quickly and buttress economic growth.

Second, these problems are not developing into systemic macro risks at this stage. Despite an increasing incidence of bankruptcy, the SME sector (read the private sector) as a whole is still underwriting steady growth. The widely reported collapse of private lending activities is isolated to particular regions, confined largely to a couple of cities in Zhejiang and Inner Mongolia.

And finally, balance sheets are still quite healthy for households, banks and the government — all of which should remain resilient even if the economic situation deteriorates. Total household borrowing is below 18 per cent of GDP, less than the value of households’ annual savings. If property prices decline modestly, households will not be forced to deleverage. And given the banks’ average non-performing loan ratio is low, at 2 per cent, and the reserve requirement ratio (RRR) is 21 per cent, some deterioration of credit quality is unlikely to make the banks dysfunctional in the near future. Public debt is only 17 per cent of GDP in China. If all contingent liabilities are included, that figure could blow out to nearly 70 per cent of GDP, but the government still has room to use fiscal resources to contain domestic risks and support economic growth.

The good news for the international economy is that the structure of Chinese growth through the new year will see gradual re-balancing toward the domestic economy. That will help relieve some of the global adjustment pressures. The sluggish external economic environment will see export and import growth likely halve to 9.8 per cent and 12.8 per cent, respectively, and a fall in net exports, accounting for almost half of the 1 percentage point drop in GDP. Despite the uncertainty surrounding housing, ‘residential investment should continue to grow in 2012 — albeit at a slower pace — due to large development projects, ongoing construction and the expansion of public housing’.

Consumption, Huang argues, will in fact be the key to maintaining the strength of the Chinese economy in 2012, although the pace of its expansion may moderate. ‘In recent years’, he points out, ‘retail sales have consistently outperformed GDP. But the GDP-by-expenditure data continuously show declining consumption, due to reporting errors in household survey data, such as the under-reporting of income and household spending. Estimates combining information from both GDP by expenditure and retail sales suggest a turning point in 2007, after which consumption’s share of GDP actually picked up steadily’. This is consistent with improvements in the Chinese social welfare system and the rapid growth that has been taking place in wage income.

All this suggests a good Chinese new year is in the offing.

And a note from the editors

The East Asia Forum continued to expand its reach in 2011. We moved to a new website and twice found we had to upgrade our server throughout the year due to increased traffic. Our hits more than doubled from 2010 and weekly email subscriptions grew by 20 per cent. We also saw rapid growth in our Facebook and Twitter presence and have started a Google+ page.

Most importantly, we have had great contributions.

The great contributions from around the region are what make EAF. It is a site owned by its contributors — a regional resource produced by analysts throughout Asia and the Pacific.

Our top most-read posts in 2011 (*some from 2010 and 2009) deserve highlighting.

1. 2011 East Asia Summit: New members, challenges and opportunities, Monica Wihardja, CSIS Jakarta
2. Japan’s earthquake and its economic impact, Peter Drysdale, ANU
3. Riding the global economic crisis in Singapore, Shandre, NUS, Singapore
4. Reforming housing for the poor in the Philippines, Marife Ballesteros, PIDS
5. The Philippines: Weak institutions drag on economic performance, Josef T. Yap, PIDS
6. The RMB and Chinese exchange rate policy: some misperceptions, Yiping Huang, Peking University and ANU
7. The impact of China’s 12th Five Year Plan, Yongsheng Zhang, DRC
8. China’s response to the global financial crisis, Yu Yongding, CASS, Beijing
9. The scale of China’s economic impact, Ligang Song, ANU
10. Vietnam’s endless corruption campaign, Long S. Le, University of Houston
11. Indonesia: Blessed by strong economic growth and the curse of resources, Thee Kian Wie, LIPI, Jakarta
12. Financial crisis: Can Asia skate through again?, Barry Eichengreen, UC Berkeley
13. Here we go again: Vietnam’s spiral of credit and devaluation, David Dapice, Harvard University
14. China’s role in running the world economy, Peter Drysdale, ANU
15. China’s rising sex ratio at birth, Zhongwei Zhao, ANU, and Wei Chen, People’s University of China
16. China’s export-led growth model, Yang Yao, Peking University

We value your feedback and wish all our readers and contributors the very best for 2012.

Peter Drysdale and Shiro Armstrong

Editors

East Asia Forum

1. Chinese economic risks
2. Five predictions for the Chinese economy in 2010
3. Thailand in 2011: a year of surprises

The dramatic increase in recent years of trade and foreign direct investment (FDI) in sub-Saharan Africa by firms from Asia — notably China and India — has become an emotionally charged and controversial issue.

For China, as Luke Hurst has written, Africa would seem an excellent complement to its resource- and market-seeking global agenda. Since 2000, China–Africa trade has grown at an average annual rate of 33.5 per cent. Although still second to the United States (whose trade with Africa amounted to US$140 billion in 2008), trade rose from US$55 billion in 2006 to around US$107 billion in 2008, accounting for 4.5 per cent of China’s total trade and surpassing the US$100 billion trade target set for 2010 at the 2006 Forum on China–Africa Cooperation (FOCAC). Trade is supported by modest yet rapidly expanding levels of direct investment, which reportedly jumped by 77 per cent in the first nine months of 2009, compared with the same period in 2008.

Most observers, says Harry Broadman, believe that Chinese (and to a lesser extent Indian) firms dominate Africa’s economies. This does not fit the facts. ‘About 90 per cent of the stock of FDI in Africa still originates from Europe and North America. FDI inflows from China have grown rapidly in recent years but the stock of capital from elsewhere is large. Nor are Chinese investors in Africa exclusively involved in natural resources’. Chinese and other investors from developing countries in Africa are increasing their investments in other sectors, such as telecommunications, financial services, food processing, manufacturing, infrastructure, back-office services and tourism. Natural resource-based investments dominate Chinese and Indian investors’ portfolios in Africa in value, Broadman points out, but the number of FDI projects by these MNEs is diversifying rapidly across many sectors.

As Deborah Brautigam points out in this week’s lead essay, Chinese development aid in Africa is also unusual in that much of the financial assistance provided does not constitute official development aid (ODA), but brings with it a focus on economic development opportunities. Much of it comes in the form of export credits and strategic lines of credit to Chinese-related companies, among other mechanisms. ‘In this sense’, she says, ‘it is very similar to Japanese financial flows to China several decades ago, when Japan began its outward march with a large line of credit to China, which, at the time, was not credit-worthy either. Looking at the nature of Chinese development aid — and non-aid — to Africa provides insights into China’s strategic approach to outward investment and economic diplomacy, even if exact figures and strategies are not easily ascertained’.

‘According to the Chinese white paper on aid released in April this year, approximately 40 per cent of China’s aid is financed through grants. Zero-interest loans are also a mainstay of China’s aid. The debt-relief program launched by Beijing in 2000 targeted overdue zero-interest loans for cancellation, with RMB25.58 billion worth (US$3.76 billion) cancelled, and of this, RMB18.96 billion (US$2.79 billion) was cancelled in Africa’.

‘Only large projects with a value of at least US$2.4 million, and that make a minimum 50 per cent use of Chinese goods and services, may be funded with concessional loans. China’s concessional loan program in Africa has grown rapidly. At the end of 2005, China Export-Import Bank had cumulatively funded only about US$800 million in concessionary loans in Africa, for 55 projects. Two years later, the number of African projects had risen to 87, and the cumulative value was about US$1.5 billion. And the government recently pledged US$10 billion in concessional/preferential credits for Africa, to be committed by 2012′.

The business-driven model of development that China now brings to Africa provides new opportunities to several African nations long overlooked — for being too high risk — as trading and investment partners. African countries and the African Union will need coherent, long-term strategies to apply leverage to international commercial interests and to create opportunities for enduring economic competitiveness and growth. But much is at stake for the 800 million people in sub-Saharan Africa, especially the 50 per cent of them who are among the world’s poorest, in the policy debate surrounding the continent’s accelerated integration into the world economy that is now prominently led by China and India.

Peter Drysdale is Editor of the East Asia Forum.

1. China and Africa: friends with benefits
2. Chinese development finance in Africa
3. India’s economic engagement with Africa

The death toll from Thailand’s worst floods in more than half a century is more than 600, millions of hectares of farmland have been inundated, 20,000 factories and plants have been damaged, some that are not likely to reopen, leaving at least 1.5 million unemployed.

As the clean-up continues, accusations of incompetence and corruption in the management of the crisis and the allocation of relief, have dominated the media and the Parliament.

The good news is that, for the first time since September 2006, when a military coup deposed the government of Thaksin Shinawatra, the country has a leadership whose legal and electoral legitimacy is acknowledged by a large majority of Thais. It is a government that decisively won a fairly contested election. It is also a government that has an opportunity to reduce, though perhaps not eliminate, the severe polarisation that has taken place in Thai society in the last decade — during Thaksin’s five years of government and in the five years of turmoil following his removal. To do that, the government led by the Pheu Thai Party of Prime Minister Yingluck Shinawatra, Thaksin’s younger sister, will have to implement the program of populist redistribution for which it has an electoral mandate. More importantly, it will also need to tackle Thailand’s long term underlying economic and social problems.

The latest issue of East Asia Forum Quarterly (EAFQ) addresses the challenges that now confront Thailand. They  include economic problems, some of which result from the difficulties of financing the promises on which Pheu Thai was elected, but also the deeper issues of competitiveness arising from the country’s outdated educational system and its ageing population. There are also problems along the borders, especially the Cambodian border, and the very different problems of the Muslim-majority southern provinces bordering Malaysia. As the six-decade reign of the 84-year-old monarch, His Majesty King Bhumibol Adulyadej, approaches its end, there is also uncertainty and disagreement about the royal succession, about which the law stifles public discussion.

In this week’s lead essay, Peter Warr, editor of this issue of EAFQ, observes that, on the economic front, Thailand is caught in a middle income trap — stalled in its ambition to graduate from a middle income to a higher income (OECD level) economy.

Progress from middle-income to higher-income levels requires a different kind of policy reform from that which lifted Thailand from backwardness to modest, if unevenly distributed, wealth over the past thirty years. Trade and other market reforms in that period saw income growth spurred by the accumulation of physical capital and people lifted out of poverty as the share of low-skilled, labour-intensive manufacturing output rose. Escaping the middle income trap, as Warr says, requires ‘addressing a market failure that the private financial system cannot resolve: the undersupply of human capital. Human capital is a crucial input, created primarily by investment in education, broadly defined. But it differs from physical capital in that it does not provide the collateral that can ensure repayment of loans. Unlike physical assets, human beings can walk away. The private financial system is therefore unable to support investment in human capital. Individual families can and do invest heavily in the education of their own children, but because their resources are limited and because the recipient of the educational investment reaps only part of the returns it generates this is insufficient to prevent the overall underinvestment in human capital’.

This is where national policy is critical and a raft of complex institutional reforms have to kick in.

Among the reforms that Warr identifies as important are reforms to Thailand’s antiquated systems of primary and secondary education, the single greatest impediment to long-term economic progress in the country; reforms aimed at lifting the long-term productivity of Thailand’s masses of unskilled and semi-skilled workers; reform of the country’s regressive and inadequate tax system; and reform of governance systems aimed at reducing corruption. Thailand’s version of economic populism will waste public revenue, feed corruption, and divert attention from dealing with the sources of long-term improvements in human productivity.

Unless Thailand deals with these issues, as Warr says, ‘the jaws of the middle-income trap will surely remain closed’.

Peter Drysdale is the Editor of the East Asia Forum

1. Thailand in 2011: a year of surprises
2. Thailand, a nation caught in the middle-income trap
3. Paying for higher education in Thailand

In Washington and Beijing last week there were important meetings that are likely to be influential in where the Trans-Pacific Partnership (TPP) negotiations on regional trade arrangements lead down the track.

In Washington, the US administration called in ambassadors from the eight negotiating partners to up the ante on an early deal. USTR Ron Kirk had declared on 30 November that the US wants a deal by the end of next year, much to the incredulity of Washington observers who doubt that the White House will want a full-on debate about the TPP and the necessary Trade Promotion Authority in the middle of an election year. Now Congressman Kevin Brady, Chairman of the Subcommittee of Trade of the House Committee on Ways and Means, has called Hearings on TPP from Wednesday, 14 December, saying that ‘it is vital that we complete an ambitious and comprehensive 21st century agreement as quickly as possible’.

China has not been invited to join the negotiations; Indonesia sees the risks of regional division and does not want to. In the end this may not matter, and both China and Indonesia have cause to be relaxed since, given the way it’s being prosecuted, the TPP may not have a substantial impact after all.

Peter Drysdale is the Editor of the East Asia Forum

1. Are there real dangers in the Trans Pacific Partnership idea?
2. The India-China Strategic Economic Dialogue
3. China and global economic governance: History matters

China’s spectacular industrial growth has been associated with equally spectacular growth in Chinese energy and resource consumption.

While Chinese energy efficiency (the amount of GDP produced per unit of energy consumed) has risen steadily, except for a few years early this decade, aggregate energy consumption has been lifted by a hugely energy-intensive phase of industrialisation and the spread of motorised transportation on a scale and at a speed that is unprecedented anywhere. China’s economic growth and the demographics will continue to underpin massive growth in energy demand.

China now consumes 47 per cent of the world’s coal, 19 per cent of its hydroelectric power, and 10 per cent of its oil. According to the International Energy Agency (IEA), China surpassed the US as the world’s largest energy consumer in 2009.

China’s dramatic change in status in global energy markets has not only surprised the rest of the world but has caught Chinese policy makers and analysts off-guard as well.

Thirty years ago, China was energy and resource self-sufficient. Indeed, on opening up to international engagement at the end of the 1970s, China was an exporter of coal and other resources, not an importer. But China’s soaring appetite for energy has driven Chinese energy users to international markets to satisfy a growth in demand that has outstripped the capacity to procure increased supplies domestically. In the meantime, some in the policy community have become nervous about growing import-dependence and ‘energy security’.

To some, who are not used to dealing in reliable international markets, any measure of import dependence appears to risk energy security. But many large resource-deficient economies, like Japan, have become used to depending on international markets for the overwhelming proportion of energy supplies to serve their industrial base. Japan relies on imports for 99.6 per cent of its oil imports at last count.

‘Energy security’ can be seen as the ability of a country to procure sufficient, affordable and reliable energy supplies. International supplies are a critical component of affordable and reliable energy for import-dependent economies, and no country is insulated from developments in international energy markets in an open global economy. But the sudden rise in energy imports and reliance on the international energy market has landed China in unfamiliar territory. ‘Energy security’ (nengyuan anquan) was a term that appeared only once in the People’s Daily in the year 2000; in the two years following 2008 the paper published 476 different articles using the term. For many Chinese observers, mounting reliance on energy imports implies external vulnerability and is a worry on both political and economic grounds. For others, the challenge is to lift national energy efficiency and ease back from over-reliance on coal with its associated environmental problems. China produces most of the coal it consumes but now draws over half of its oil supplies from overseas. The IEA projects that, by 2035, China will import nearly 12.8 million barrels per day, or 84 per cent of its total supply.

As Andy Kennedy points out in this week’s lead essay, China has adopted a variety of supply-side policies to ensure its access to oil supplies over the next several decades. Most, he concludes, have been ineffective, wrongly directed, or are under-developed.

The Chinese government ‘has encouraged its national oil companies (NOCs) and other state-owned enterprises to ‘go out’ — to invest overseas and gain greater access to resources abroad’. At the beginning of last year, the NOCs had equity in overseas production of 1.36 million barrels per day — nearly one-third of China’s net imports in the previous year. But has this has enhanced China’s energy security?

The NOCs don’t necessarily send the oil they produce overseas back to China. Nor is it reasonable to assume that oil produced by the NOCs would somehow be cheaper or more readily available to China in a supply crisis. Physical disruptions that impede the flow of oil to China will affect foreign and Chinese firms alike, and the NOCs, seeking profits in the international market as they are, have shown little inclination to give Chinese customers a discount when prices are high.

‘China is also diversifying the sources of its oil imports away from Middle Eastern suppliers’, says Kennedy, ‘its ‘loans for oil’ deals in recent years have facilitated long-term contracts with a range of oil-producing countries in other parts of the world — including Russia, Brazil and Venezuela’. Yet this has had a marginal effect on reliance on supplies from the Persian Gulf.

China is also building its naval capabilities to secure its sea lanes, although it is doubtful that anything other than an anti-piracy capability is a sound investment in the relevant timeframe.

And China is building its Strategic Petroleum Reserve to cover 63 days worth of net imports in an emergency at levels projected in 2020. To be effective, Chinese reserve strategies will have to be coordinated with those of other major importers.

China’s growing position in the international market makes reliance on unilateral and bilateral measures to reduce its vulnerability to oil-supply shocks a doubtful strategy. China will need to pursue greater coordination with other major oil importers through the IEA and develop the multilateral side of its approach to energy security. China is not yet a member of the IEA: it needs to be. Multilateral engagement would provide Beijing with more information and greater influence in the event of future supply shocks — a danger that faces other oil importers as much as it faces China, around uncertainties in the Middle East. ‘Greater multilateral engagement would also demonstrate that Beijing is looking for ways to cooperate with the international community as the story of China’s rise continues to unfold’, as Kennedy argues.

Yet there is no global regime that protects importer interests in reliable energy supply as there is for reliable market access under the WTO. That was one dream in the Atlantic Charter never realised in the Bretton Woods architecture after the Second World War. What there is by way of substitute is a complex surrogate of understandings and agreements, bilateral and global, that work to project the same effect. This is why for big (non-oil) energy exporters, like Australia, assurances of reliable energy and resource supply to major importers such as Japan, China and Korea are important to confidence in international resource markets. It is also why China, the United States, Japan and other major oil importers understandably expend as much diplomatic effort and good will as they do in the Middle East.

Peter Drysdale is the Editor of the East Asia Forum.

1. What does the Middle East situation mean for energy supplies?
2. China’s petroleum predicament
3. Dealing with China’s energy and resource insecurities – Weekly editorial