The PLA, Trade, and U.S. Interests
Kevin G. Nealer
The military capability of any country is shaped not only by policy and defense budget choices but also by the larger economic environment in which the country is operating. Therefore, this essay begins with an overview of the current macroeconomic environment facing China and other countries in the region.
The rate of growth of Chinese exports experienced some significant declines early last year. Since the beginning of 2001, exports that have enjoyed traditional strength (notably apparel) have declined. While exports growth returned in 2001, such downturns remind Chinese businesses that they are not immune from economic cycles in Asia and the United States.
In Japan, trade sensitivity regarding Chinese agricultural products and select manufactured goods from China has created turbulence between the two countries, and it is likely that China's other trading partners (including the United States) will be increasingly concerned about domestic import sensitivities resulting from Chinese products.
In addition, it appears that China is reaching the top of its labor cost advantage and will begin to face increased competition from other developing nations to be the low-cost producer of domestic and foreign products.
Coping with WTO Commitments
China is challenged by the fact that, after 15 years of negotiations, it is now a member of the World Trade Organization (WTO). The Chinese leadership has bet on WTO as an organizing principle for the final stage of reform of its state enterprises. While foreigners should be encouraged by China's commitment to live by international norms in conducting its global trade and investment policies, WTO obligations will test the limits of China's tolerance for deeper economic reforms.
WTO commitments will accelerate social adjustment brought about as the result of pressures from increased imports and a decreased obligation to locally source product input. This will exacerbate unemployment. Over 6.5 million urban workers lost their jobs in 1999, and there were an additional 2 million more through mid 2000, not including the rural jobless, who are not recorded in official tallies.
Modifications of over 1,000 domestic laws and regulations will put pressure on the Chinese legal system, which, as a civil law structure, is less adaptable than common law systems. (China's court system is unaccustomed to hearing challenges to existing laws and regulations, and provincial judicial systems are often unaware of changes made to existing laws for a significant period of time.)
China has seen breathtaking growth along the coastal region, but 7 out of 10 Chinese citizens still reside in rural communities, where they are less likely to find employment in growing sectors of exporting industries. WTO-induced growth is likely to widen the income disparity between coastal and inland residents.
Domestic growth of more than 6 percent seems sustainable; however, China is likely to face declining exports in the coming year, and there may also be a lessened appetite for Chinese corporate listings in Hong Kong and the United States. Much of the anticipated cleanup of the financial sector has been deferred; even access to the second largest pool of hard currency in the world cannot protect these firms from consolidation.
Issues relating to Chinese defense spending are common knowledge (see figure 14-1); however, these issues do need to be placed in a broader context (see figure 14-2). China announced a budget increase in March 2001 in education, science and technology, agriculture, and defense spending. The allocation of financial resources within the military is scheduled to be dispersed among China's 2.5 million troops and civil employees, as well as to finance the garrison in Macau. Conventional wisdom says that a large portion of the remaining money in the budget will be used to upgrade current military technology.
How is China sustaining this budget increase while trying to avoid contraction and declining demand (see figure 14-3)? The surprising thing about the list of policy options is their similarity to the toolbox used in fully marketized economies, such as America's. The cautionary tale here is that, as the devices for state planning have been relaxed over the past decade, the central government's ability to adjust through market controls (such as wage and price adjustments and state purchasing) have diminished toward the vanishing point. Even fewer of these tools and administrative guides will be available after WTO implementation.
A decade ago, we were concerned about "trade as treason"--that is, trading with statist firms that passed knowledge and equipment on to the People's Liberation Army (PLA). With divestiture of PLA enterprises well under way (see figure 14-4), the risks are exquisitely subtler. The volumes of commerce we are talking about now are considerable (see figure 14-5). Total Sino-American trade this year will total nearly $140 billion. China's global imports and exports totaled about $600 billion last year. Increasingly, this reflects higher levels of technology on both sides. When China was selling us swizzle sticks and Barbie dolls a decade ago, technology transfer issues were easy to detect. Now the Chinese exports have moved downstream and are far more sophisticated (for example, digital cameras and videocassette recorders). Accordingly, the inputs needed to turn them out, including software, are far more sophisticated.
Analysts tend to focus on trade in goods in examining defense related contributions; however, there is a growing realization that money is fungible and that investment is strategically significant. To offer a sense of perspective, total global trade in goods amounts to an estimated $6 trillion annually. This contrasts with currency clearances every day of well over $800 billion, meaning that nearly as much money moves around the world every week as the total volume of goods trade in a year.
For China (see figure 14-6), $8 billion in U.S. inward investment is a very small part of the story. For most of the past decade, China has captured one out of every three dollars going into the developing world. This "big sucking sound" has a crowding effect on credit markets, reducing the funds available for investment in other developing markets.
The Investment Dilemma
There are increasing calls in the U.S. Congress for limits on China's access to American capital markets. At a first order, this is an effort to constrain the ability of Chinese companies to strengthen themselves as competitors by using equity and debt. In addition, the theory is that foreign investors are unwittingly capitalizing the PLA because access to foreign funding frees up Chinese assets to support military expansion. Assuming a one-to-one correlation between Chinese corporate wealth and the PLA budget is unsupportable. The PLA competes for funds in the Chinese budget. While the military is clearly modernizing, it does not make sense to imagine that denying capital to either state sector or quasi-private ventures in any way inhibits PLA plans.
In fact, with increased access to the international securities market, there is a growing requirement for visibility and full disclosure about the structure and financing of these firms. In fact, we likely know more about the structure, functions, and relative health of Chinese companies as a result of reporting obligations associated with their increased reliance on foreign capital than from all of the sleuthing and conventional investigations of the past decade. The Bank of International Settlements, international accounting requirements, and reporting obligations are opening the books on Chinese companies and their practices. The picture is far from complete but comparable in many ways to Japan and South Korea. Shutting them off from capital shuts us off from participation and knowledge. Since capital markets are truly global, U.S. allies will not hesitate to participate in a good deal.
Export Control and Proliferation Concerns
If the United States accepts that trade leads the bilateral relationship, that it is broad and deep, and that it is likely to become more so, where does that leave how we think about diversion risks and export controls and exploitation of civilian technologies by the PLA?
Alfred Wilhelm has reviewed the terms of debate on military/military contacts. I cannot improve on what he wrote in considering the trade implications for dealing with the military, other than offer Larry Wortzel's cautionary criteria:
Larry Wortzel and others like Paul Godwin and Bernard Cole have made the case that the legitimate areas of concern are:
As we consider renewal of the Export Administration Act, the direction of technology controls is clear. There is the need for fewer but higher fences around systems and capabilities that matter most to the United States in terms of risks to defensive and offensive capabilities. The notion of temporal speed bumps, essentially our current policy of keeping critical systems more than two generations behind in any sensitive exports of production technologies, should be considered also. The issue of what constitutes a generational shift is a matter of hot debate in the high-tech community. Bear in mind that American companies exercise a high degree of discipline over technology transfers for their own good commercial reasons. They are not unwilling participants in this process, and they often enjoy parrying the demands of Chinese partners for the best technology with demurrals based on U.S. law and policy.
Has PLA defense divestiture made it harder to tell legitimate commercial firms and purposes from those seeking military technologies? Yes, but in our experience with commercial transactions, it is fairly clear that most for-profit companies take care of their own interests with little regard for the military's wish list. This is not to say that covert programs are not filling PLA shopping lists, but for the most part, for-profit companies are unresponsive. They simply do not share the state sector's priorities or interests and are not willing to compromise essential business goals to help aggrandize PLA capabilities.
There are companies whose history and culture remain reliant on PLA contacts and purchases, which present more troublesome issues. Huawei has been cited as an example, as well as the Poly Group. With companies such as these, we see a need to do a finer-grain analysis and to look at what business units are involved and for what purposes. To a large extent, when we talk about improving Chinese military capability through trade, the risk points are Russia and Israel.
What about the other side of the coin, meaning China's record as an exporter of dangerous technologies and role as proliferator? The experience here is uneven. We have seen sanctions in 1991 and 1993 and Chemical Weapons Convention sanctions. We are now coping with the Helms sanctions, and there was to have been a fix at the recent Shanghai Summit, though the Chinese were unable to pick up the deal that was on the table so the decision may be deferred.
Finally, there are two trends: One is Chinese ability, and ours, to differentiate between acts of companies and state acts so that we are both identifying bad actors, not raising every issue to the level of state-to-state action. The other is a general trend, of which WTO membership is evidence, to seek the norms of the international system, not out of any sense of obligation, but because it is in China's self-interest.
The story of Ambassador Richard Armitage's meeting with the Pakistani Interior Minister is well known, as is Armitage's pronouncement that "History begins today." There is reason for hope that September 11, 2001, will become a catalyst for Chinese views on proliferation risk and that we can use this moment to encourage the instinct to restraint, to the extent it now exists in the Chinese view of self-interest.
By all events, Sino-American trade relations are condemned to become more complicated over time. While a high degree of caution is essential in protecting American security and commercial interests, the U.S. approach also must be part of a well-considered international effort, if it is to succeed.
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