One of Winston Churchill’s oft repeated saying was, “I cannot forecast to you the action of Russia. It is a riddle wrapped in a mystery inside an enigma.”
Of late, China has become a Russian-level conundrum to the wider world. Developed economies are troubled by Middle Kingdom’s increasingly aggressive economic stance; neighboring countries are rattled by its recent belligerence. China’s recent use, or as some might characterize it, overuse of force, is a departure from past policies. As the Financial Times notes:
“In the last 12 months, they have managed to undermine everything they achieved in the past 12 years around China’s periphery in terms of smoothing diplomatic relations,” says Prof [David] Shambaugh [a China expert at George Washington University].
The Financial Times piece,”China: View from the inside” and a Foreign Policy article by Kerry Brown, “The Power Struggle Among China’s Elite” (hat tip reader Don B) both endeavor to shed light on this behavior change. The FT story covers ground that is familiar, in that it rings the changes on issues often presented by Chinese leaders and spokesmen, that of a misunderstood power seeking to claim its rightful place on the world stage. By contrast, the Brown story makes it clear that China is going through a political transition that makes it particularly hard for outsiders to read. And that greatly increases the odds of misunderstanding and miscalculation.
The Financial Times’ framing is conventional:
…the country is being challenged on central parts of its foreign policy, economic strategy and domestic political system – all at the same time…
The proliferation of disputes is unlikely to lead to a breakdown in international relations. However, it does suggest China’s ascendance in recent years has been so dramatic that governments around the world, as well as Beijing itself, are still struggling to adjust.
To the Chinese leadership, the tension sometimes appears to stem from the discomfort of a developed world demoralised by the financial crisis Yet in many capitals the situation looks very different – more like a confluence of domestic caution and diplomatic overconfidence resulting in miscalculations on Beijing’s part.
And this conventional posture means it leaves some assumptions on the part of the West unchallenged:
Beijing abandoned its dollar peg in June – but then allowed the renminbi to rise by only 0.5 per cent over the following two months.
“They were very slow to see how this would play in US politics,” says one European diplomat in Beijing. “If they had just let the currency rise by 2 or 3 per cent in the first month or so, which would not have affected exporters that much, this dispute would not have come alive again in the same way.” After renewed pressure from Washington, the renminbi has now risen 2.5 per cent since June.
Yves here. As we’ve indicated, the “abandoning the dollar peg” interpretation of the June announcement was dead wrong; we parsed the Chinese statement and concluded it committed China to do absolutely nothing, and were pretty much alone in correctly deeming the widely celebrated statement as a headfake. China has allowed the renminbi to increase in the last month or so only because criticism in the US has reached a fever pitch, and Congress took a baby step towards retaliation.
But as we have pointed out in the past, many Chinese exporters operate on such thin margins that they will become unprofitable if the renminbi rises much (see this and this on the lack of competitiveness of many Chinese exporters). Per the Financial Times earlier this month:
Mr Wen hit back at international criticism of China’s currency policy, saying that acceding to demands for a faster rise in the renminbi could cause social unrest in China.
“Do not work to pressurise us on the renminbi rate,” Mr Wen said, departing from prepared remarks. He said Chinese export companies had very small profit margins, which could be wiped out by actions such as the currency import tariffs the US Congress is threatening to impose.
“Many of our exporting companies would have to close down, migrant workers would have to return to their villages,” Mr Wen said. “If China saw social and economic turbulence, then it would be a disaster for the world.”
A story today from the South China Morning Post (hat tip reader Kevin R) provides further support:
According to a recent survey by the Central University of Finance and Economics in Beijing, 57 per cent of small and medium-sized export companies are having to survive on profit of less than 5 per cent.
A rise in the yuan’s value of just 3 to 5 per cent could wipe out the profit of most of these companies or even plunge them into the red. Since Beijing announced in late June that it was abandoning its temporary peg to the US dollar, the dollar-yuan rate has already strengthened 2 per cent.
Local media in some coastal cities have already reported an outflow of capital from traditional manufacturing areas because of fears that the yuan’s gains will cause trading losses.
Chinese-language media have been calling for the government to draw a clear “red line” for the dollar-yuan rate. One column in Securities Daily, signed by Wang Yong, argued that the government should not allow the yuan to appreciate more than 3 per cent in 2010. Once the so-called “red line” was broken, the government must intervene. If the change is as large as 5 per cent, experts say, even the top companies will suffer losses. “All their advantage would vanish,” Wang said.
The implication is that a meaningful number of Chinese businessmen and their employees feel deeply threatened by foreign pressure for a stronger currency. This strong-arming plays into an already volatile political dynamic. Per Foreign Affairs:
The real power is in the Politburo of the Communist Party — and, to be precise, in its nine-member-strong standing committee…
This Chinese “elite of elites” is somewhat distracted at the moment. In about two years’ time, seven of the current nine will have reached retirement age and will need to step aside. Every five years, during the party congress, the next generation of leaders is elevated, and 2012 is going to be a big year: We will see a shift from the “fourth generation” of Chinese leaders under President Hu Jintao and Premier Wen Jiabao to a “fifth.” A new era will start…
Only this time there are a couple of problems. The first is that there is no powerful elder patron who can direct this whole process smoothly…. So the transition this time will be without a patriarch’s guiding hand. That means that while politburos before have had high turnovers, the impact of a large number retiring this time could be far more destabilizing.
No one knows what kind of battles might be taking place now in the central government compound in Beijing where the key leaders live and work. The politburos under Hu and Wen have been watertight. Nothing much gets out about who supports whom, and who is in favor, who in danger.
The article stresses that the Chinese leadership is so hermetic that China watchers probably will not be able to identify the dynamics of the current power struggle even after the fact.
Needless to say, this is a very large blind spot at a crucial time. And there are reasons to suspect the obvious, that the new found international aggressiveness is a useful outlet for domestic tensions:
As in other political cultures, foreign policy is an easy way for Chinese leaders to outmaneuver their opponents….Of all the many things we don’t know about who the next leaders of China might be, there are a few things we can be certain about. Whoever the leaders are, they will not be technocrats the way the previous generation was. There will be political scientists, economists, and lawyers running China into the future now — very much like in the West. The era of the engineers and geologists is coming to an end.
China’s new leaders will have no immediately obvious link to the military. None of the likely candidates for leadership after 2012 has ever served in the army, or ever directed it. But most ominous of all, because of their age (mid-50s onward) they will all be people who were brought up and educated during the 1966-1976 Cultural Revolution, the most closed, xenophobic era in post-1949 Chinese history. None will have studied abroad for any length of time, and they will all have limited international experience.
Yves here. This situation is ripe for miscalculation: virtually no international insight into the transition dynamics in China; an incoming leadership with scarce foreign experience and possibly deep seated animosity; particularly high stakes on both sides. Reader Vlad Ender warned via e-mail how situations like this can easily devolve into overt conflict:
I remembered what game theory says about brinkmanship and bargaining – both parties want to avoid the worst outcome, yet if their belief of their costs are lower than their opponents, it will end up in tears.
I think the situation is made yet more dangerous by US increasing threats (again, brinkmanship), but by so small steps that China disbelieves credibility of any of those. Thus it disbelieves that the situation actually moved – but from US perspective it does. At some time US may think it has to commit an action which from its perspective is only small escalation, but from China’s (who might have ignored all the previous signals) it’s a huge jump.
The worst of this situation is that reducing the degree of US and Chinese economic co-dependence would be a fraught task even with much more seasoned internationalists at the helm of both countries. The shifting political tides here and in China increase the already uncomfortably high odds of a bad outcome.