Chapter Eighteen

The United States and China: Time for a Change

Richard C. Thornton

It is not enough to remember the past; it is imperative that one understands it. Before proposing a policy for the path ahead, this essay discusses the key decisions that have brought our relationship with China to the point it is today.

The Evolution of U.S.-China Relations

From Richard Nixon's opening to China until the collapse of the Soviet Union in 1991, U.S. policy toward China was a function of strategy toward the Soviet Union. American leaders were of two minds, however, in this regard. One faction, the new world order faction, saw policy toward China and other states subordinate to the development of détente with Moscow, the central axis of American strategy.

The other faction, the containment group, saw the Soviets as an adversary and sought to employ China as a counterweight to growing Soviet power. China policy fluctuated by administration and the faction in control of American policy. In the past three decades, however, the containment faction prevailed only during two brief periods: Nixon's first term and the first 6 years of the Reagan administration.

Nixon's opening to China was intended as a means of employing China as a counterweight to the Soviet Union in the context of his Vietnam exit strategy, and Mao Zedong reciprocated by preparing to shift into the American sphere as part of an anti-Soviet "alliance." But, when Nixon faltered, Henry Kissinger turned American strategy away from containment and toward a search for détente with Moscow. A downturn in U.S. relations with China was the result.

The turn in American strategy was matched by a shift in Chinese strategy as Mao, too, faltered and was replaced by Deng. As Kissinger pursued détente with Moscow, Deng Xiaoping sought to play Washington off Moscow, and from 1974 until the collapse of the Soviet Union in 1991, Deng attempted to occupy the middle position between the United States and the Soviet Union whenever feasible.

President Jimmy Carter continued the Kissinger strategy toward the Soviet Union and China until 1978, when he initiated the normalization process. Although Zbigniew Brzezinski hoped to employ normalization of relations with China as a means of strengthening the containment of the Soviet Union, Carter never fully abandoned the détente strategy.

It was not until Ronald Reagan became President and scrapped the failed strategy of détente that the United States once again sought to strengthen China as a counterweight to the Soviet Union. The 1982 August communiqué, whose surface aspect was a modus vivendi on Taiwan, marked a historic U.S. decision to increase the flow of technology, resources, investment, and trade to China. The essential bargain between Reagan and Deng Xiaoping was that in return for setting aside the issue of Taiwan as an obstacle to improvement of relations, the United States would assist China's economic development. Reagan hoped that this bargain would translate into the emergence of China as a counterweight to the Soviet Union, but it did not. Nevertheless, the bargain held through the Reagan administration, even though at its end Secretary of State George Shultz once again changed American strategy from Reagan's containment back to Kissinger's détente with Moscow.

The collapse of the Soviet Union fundamentally altered the strategic environment and led to further changes in both American and Chinese strategy. In a search for a new strategic partner, the United States, under George H.W. Bush, chose China to fill the vacuum created by the demise of the Soviet Union--a role that China in turn chose to fill. In short, if the collapse of the Soviet Union created a temporary strategic quandary for the United States, it offered Beijing the greatest unrequited opportunity in China's history to attempt to supplant Moscow and achieve a dominant position in the Far East.

The problem was, of course, that China was too weak to be a genuine partner. Therefore, the United States decided to help. Understand, too, the decision to build up China was not for it to be a counterweight to Russia but to replace Russia. In my humble opinion, we need a deeper inquiry into the circumstances surrounding this decision. It seems to be nothing less than a replay of the Kissinger strategy toward the Soviet Union of extending trade and technology in return for cooperation and the maintenance of stability. If that was the rationale, it failed in the China case the way it did in the Soviet. Regardless of the rationale, however, it was a decision that William Clinton carried to extraordinary lengths.

It is a truism that a country's foreign policy is a direct function of its economic power. And the extent and scale of American assistance in the development of China's economic base during the Clinton Presidency were enormous, as a few facts from the history of foreign direct investment (FDI) in China illustrate. Although Deng Xiaoping declared China's opening to the West in 1978, FDI was negligible between 1978 and 1982. Following the August 1982 agreement, however, that picture began to change, albeit still quite slowly. Between 1982 and 1991, FDI increased but never exceeded $3 billion in any given year, and the total was less than $20 billion.

The great surge in FDI began in 1992, when the decision had been made to build China into a strategic partner. The Chinese reciprocated by removing barriers and enacting enabling laws, but none of that would have mattered had the United States not made the decision to help. Between 1992 and 2000, FDI skyrocketed, reaching $40 billion in 2000 and possibly $46 billion in 2001, and to a cumulative total of some $400 billion in less than a decade. Combined with trade and technology transfer, this amounted to a truly massive shift of Western resources to China, greater and faster than any other shift of resources in the history of the world.

In other words, it was less than a decade ago that China truly began to develop the economic power on which it now bases an increasingly challenging strategy today. The adoption of this strategy has been premature, for the modern sector of the Chinese economy is quite vulnerable to external forces. China has not yet developed a self-sustaining, modern economy that can independently generate the level of wealth required to support the technological requirements of its strategy. Moreover, China's strategy is self-defeating, challenging the very country responsible for its present position. In short, the Chinese economy is too young, fragile, and dependent upon external inputs to support its current strategy. That is China's weakness. Its strategy can only succeed if we allow it to--and vice versa.

What is China's strategy? It is, of course, to make China into a great power, drawing upon the resources of both East and West to do it. The first requirement for success has been to strengthen the economic base and construct a hard-currency-generating economic system. The means to this end has been an export-led growth strategy, including the construction of Western export platforms containing the latest manufacturing technology, thus enabling Beijing to acquire wealth and technology from the West and to undertake what has truly been a Great Leap Forward. But the hard-currency-generating economic base has yet to be constructed.

China has accumulated an enormous hard currency reserve, estimated to reach $200 billion in 2001, the cumulative product of a large annual trade surplus with the United States. But instead of using this reserve of wealth to transform the Chinese economy, the Chinese have employed it to acquire a sophisticated arsenal of weaponry from the Russians. With Western wealth and Russian weapons, China now poses a challenge to the United States in Asia.

Enjoying this apparent best of both worlds, Chinese leaders anticipate that the growth in intimidating military power will enable them to restructure the Asian political balance to advantage, perhaps, as Sun Tsu would say, "winning the war without fighting a battle." The hoped-for outcome is abundantly clear: China will become the new power center of Asia, displacing the United States, absorbing Taiwan, coopting Russia, and drawing Japan and South Korea into its orbit. Were this strategy to succeed, China would indeed become a global power of the first rank, perhaps eclipsing the United States.

In retrospect, the general turn in Chinese strategy was signaled in the change in policy toward Taiwan in 1995. Some have mistaken the change as a regime survival issue, as Taiwan's move toward genuine democracy put its absorption farther out of reach, but that is not the case. Like the Chinese saying "jr sang ma huai" (to point at the small leaf but curse the big leaf), Chinese policy toward Taiwan represents a general challenge to the United States in the Far East.

Until 6 years ago, the Taiwan question had been dealt with according to the bargain reached with Reagan in 1982. The essence of that agreement was that the United States would gradually reduce the quantity and quality of armaments that it would provide Taiwan, but only as long as the Chinese pursued a peaceful approach toward resolution of their dispute. Were the Chinese to break that bargain, the United States would reassess its policy.

The Chinese made clear that Jiang Zemin's 8-point proposal for reunification in 1995 ended the bargain on Taiwan. Even though his proposal set no ultimatum, it was a signal that a tougher policy was coming in the absence of capitulation by Taipei. The subsequent missile shots bracketing the island before the 1996 election were an unmistakable signal, as was General Xiong Guangkai's nuclear threat that "Washington cares more about Los Angeles than about Taipei."

But Clinton had decided that he had too much invested in the strategic partnership to reassess China policy and so did what he vowed he would never do: he coddled dictators. The 1996 election year saw Clinton's policy of "engagement" move into high gear as export controls were removed on the sale of advanced computers and satellites and missile technology "transferred" to China. Even U.S. nuclear weapons laboratories opened for Chinese perusal.

In return, the Chinese pumped millions of dollars into Clinton's campaign coffers through various intermediaries. They could be forgiven for acting as if they had bought a President, if not the entire American leadership establishment. The Clinton rollover only encouraged the Chinese to believe that they could flaunt any agreements made with the United States.

And flaunt agreements they have. The list is long. For example, promising to open its markets, accession to the World Trade Organization (WTO) notwithstanding, China practices blatant neomercantilist protectionism. Claiming improved human rights practices, China continues to arrest and execute dissidents, even American citizens. Agreeing to protect intellectual property rights, China permits gross piracy of patented products and processes. Promising to curtail illegal emigration, China looks the other way as thousands seek sanctuary on American shores. Promising to use dual-use technology solely for civilian purposes, China diverts such technology for military purposes. Committed to adhere to the Missile Technology Control Regime, China continues to export missiles. Promising to adhere to the Comprehensive Test Ban Treaty, China continues to test nuclear weapons. Promising to desist from exporting nuclear technology, China exports nuclear technology all the same. Acquiescence has only emboldened Beijing in the belief that American capitalists care only for profits, not principle.

During the 1990s, the Chinese also became active in staking out positions beyond their borders, which indicates very ambitious future objectives. They have established relations with the former Soviet Central Asian republics, the Shanghai Five Agreement, not to mention reestablishing the Sino-Russian alliance. They are increasingly asserting their "maritime rights" in the Sea of Japan, mapping the sea floor. They have claimed the entire South China Sea as their own territorial waters, fortifying islands positions there, and are constructing a protective/coercive corridor from China to the Persian Gulf, through the supply of weaponry to nations along this waterway, including Burma. Indeed, the objective appears to be to take positions that would enable them to threaten to interdict the flow of goods from Japan, South Korea, and Taiwan to the west as well as the flow of oil from the Gulf.

In embarking upon this strategy, the Chinese have borrowed heavily from the former Soviet Union in regard to the employment of missile power, which explains their hostility to missile defense. No doubt the Russians have eagerly proffered their advice, for a Chinese challenge of the United States serves Russian long-term strategy.

The Soviet Union constructed a large, intermediate-range missile network that enabled Moscow to target virtually every nation in the Eastern Hemisphere. The Chinese appear to be in the early stages of doing the same. The ballistic missile network deployed along the coast enables the Chinese to target South Korea and Japan, in addition to Taiwan. China's support for North Korea's missile program also carries a thinly veiled threat to Japan and the U.S. position on Okinawa.

Of course, Chinese capability lags significantly behind that of the United States, but they do not need an equivalent capability to ours to be able to challenge us in the Far East. The heavy Chinese investment in ballistic and cruise missile systems, aircraft carriers, advanced fighter aircraft, attack and missile submarines, and antiship weapons clearly foreshadows a future intention to contest the United States for, at a minimum, maritime supremacy in the Far East.

The testing process has already begun, and the Chinese must be encouraged by the way the United States meekly responded to the latest challenge, the EP-3 incident. We possess but have not released tapes that I believe would show the Chinese deliberately provoked the incident and forced the aircraft down. By declining to expose their ploy, they must conclude that we are still fearful of causing a disruption of our relationship.

The United States and China

Thus far, I have tried to establish three propositions--that Chinese strategy has changed and now aims to displace the United States from East Asia; that the United States has played a crucial role in China's growth in power; and that China's power nevertheless rests on an extremely fragile economic base.

These three propositions form the context in which to address the issue of future American policy. After all, as American policy has been instrumental in establishing the conditions for the growth of Chinese power, it can also be instrumental in changing those conditions. I submit that it is within our power to tame the Chinese dragon and bring about a transition to peaceful relations in East Asia. Moreover, the time is ripe for change.

The success of Chinese strategy will require greater wealth than they now possess, good fortune, and American acquiescence. China depends fundamentally upon the good will of the United States to succeed, just as the Russians did. Atrophy of the link to the West will inevitably undermine, if not derail, the Chinese strategy, just as it did the Soviet one. The fundamental contradiction in Chinese (and Soviet) strategy is Beijing's dependence upon access to the wealth of the United States even as it attempts to challenge the United States.

The Soviet Union collapsed because the Russians did not have sufficient wealth to surmount their economic and technological backwardness when the United States decided to bring détente to an end. At the same time, their inability to match the Reagan administration's military modernization program exposed the fragility of the Soviet Union's technological-economic base and spelled the doom of Soviet strategy. Despite Mikhail Gorbachev's subsequent efforts to change strategy, constrict empire, and cut costs, the continuing inability to develop a viable economy led to collapse of the state.

China is in both a stronger and a weaker position than the Russians were in different ways. While the future may look rosy for China at the moment, it is facing a predicament at least as if not more difficult today than the Soviets faced in the early 1980s. For China, 2001 is like 1981 was for the Soviet Union. Like the Soviets, the Chinese have come to believe that rapid modernization is within their grasp, that the United States and the West will continue to pour wealth, technology, and human expertise into China indefinitely, that superpower status is inevitable, and that China will soon be equal or superior to the United States. Like the Russians, the Chinese believe that capitalist greed will insure that we sell the rope and tie the noose they will loop around our collective necks.

Like the Soviets in 1981, China has experienced the benefits of a lengthy period of détente and extensive trade with the West, accompanied by a heavy flow of wealth and high technology. Like the Soviets in 1981, the Chinese believe in the permanence of hard currency flows for the indefinite future to pay for this buildup. And like the Soviets in 1981, there is the soothing patois of businessmen, intellectuals, political leaders, and military leaders of all stripes urging the United States to continue along the path to engagement, the synonym for "détente."

I believe that we have reached the moment when we must turn the page on China policy, deflating overambitious Chinese aspirations, and disabusing them of any hope of displacing the United States as the hegemonic power in the Far East. The way to address the China problem, however, is not through military confrontation, although if the Chinese choose confrontation, we must be prepared and not shrink from it, as we did in the EP-3 incident.

The way to deal with China is the same way we dealt with the Soviet Union. We must apply the Reagan formula: constrict trade, staunch the flow of high technology and investment, and severely inhibit Chinese ability to acquire hard currency. At the same time, we must demonstrate our superiority by building a military capability they cannot match. Missile defense must occupy center stage in that effort because missile offense is the centerpiece of their strategy, just as it was the Soviet.

The essence of the solution to the China problem is to constrict severely Beijing's future ability to accumulate hard currency on anything like the scale accumulated in the past decade. Fortunately, three factors are converging that make this possible. First is the global economic recession, which began earlier this year. Second is the war on terrorism following the events of September 11, and third is the Chinese leadership's own decision to enter the World Trade Organization.

In theory, WTO entry over the next few years will throw open all of China's economic sectors to greater domestic and foreign competition, sharpening the contradictions between stagnant communism and modern capitalism. China stands at the point of no return, and only three things can happen. China will make the adjustments necessary and lay a strong foundation for future growth; stagnate in an attempt to cheat its way around WTO rules, essentially changing little; or falter and slide into turmoil.

The Chinese have said that they will try to maintain the best of all possible worlds, maximizing their profits, and delaying and minimizing their commitments. In a recent interview, vice-minister Long Youngtu said that during the 5-year accession period, China plans to delay commitments on market access for as long as possible while exporting the maximum. He indicated that they will only "gradually" reduce tariffs and export subsidies and will seek the West's agreement to restrain use of antidumping measures against China.

Most important, no matter which path they choose, it will be accompanied by increased social tension and repression as the regime attempts to suppress the inevitable dissent that the WTO process will produce inside China itself. That dissent will be from both those who benefit from modernization--the demands of rising expectations, including demands for political democracy--and from those who do not benefit and despair at the price they will be forced to pay.

We must help this process along. Chinese exports had already begun to shrink and inventories grow as the global recession began to hit in early 2001. In fact, Chinese exports have already shrunk by a quarter compared to 2000. When recovery begins, as it inevitably will, we will have to find other means to discourage imports from China. These means are at hand.

For example, the Iran-Libya Sanctions Act, first passed in 1996 and renewed in August 2001, authorizes the U.S. Government to cut imports from any company making energy investments in Iran or Libya, both of which have been named by the United States as state sponsors of terrorism. Any contract over $20 million triggers sanctions. China has been heavily involved in Iran for some years. Indeed, Sinopec just signed a $160 million contract for energy development. Thus, China already qualifies under this law alone.

Also, the Iran-Iraq Arms Nonproliferation Act of 1992 calls for the imposition of sanctions on any state assisting either of these two in the development of their weapons programs. The Chinese qualify here, too, and under the Arms Export Control Act, the United States has imposed "wrist-slap" sanctions on a Chinese company for the sale of nuclear equipment to Pakistan. The Chinese already have broken their pledge of November 2000 that they would not export material designed to assist countries to develop nuclear missile systems.

In addition to discouraging trade, the U.S. Government should also encourage investors to look elsewhere. With sufficient incentives, investment into other areas and countries can be made profitable, offsetting China's low labor cost advantages. Our own hemisphere would be a productive area where the result is less likely to produce a challenge to American interests. If capitalists truly care only for profits, then investments will not be China-bound.

Would that strategy really work? China has a huge domestic economy. To a certain extent, it could compensate for any action we would take. And that is what Henry Kissinger believes. In a recent interview, he declared, "We cannot prevent China's growth. If we try, they will only grow a little slower, but we will guarantee that they will be an enemy." Since China already is an adversary, if not an enemy, we lose little and perhaps gain a great deal by having it grow a little slower.

But the hard facts are that trade and FDI combined account for over 40 percent of China's gross domestic product (GDP). The United States and Japan each take 20 percent of China's exports. It is China's Achilles' heel. A significant, prolonged decline in both of these areas would not only slow down China's growth rate, but it also would seriously impact its military spending, which is tied to hard currency earnings. In addition, the costs of managing WTO entry will impose further constraints on Beijing's ability to squeeze the domestic economy to pay for continued military modernization.

The Soviet Union took a decade to collapse. It may take longer to rein in China. Results will not be visible immediately because China's large currency reserve would enable it to cushion short-term effects. And they would complain both directly and through their agents of influence in the United States. But once the Chinese realize that we have become serious, their policies would change. And that is the object. In truth, the Chinese are in this way worse off than the Soviets were because their economic health is tied more directly to the United States than the Soviet Union's ever was.

The Chinese already see the problems coming and realize that the quality of their growth remains fragile. They are in the fifth year of a large fiscal stimulus program designed to expand their infrastructure base, but the problem is monumental and their resources too few. The Chinese economic base vis-à-vis its military structure is in better balance than the Soviet Union's was. The Soviet Union had a major military overhang, but the Chinese economic base is not as broad as many think. The effective base is relatively narrow. The high-tech sector of their military is not yet disproportionately large, but it is getting there.

China is a financial basket case. Officially, domestic debt is 15 percent of GDP, but when contingent liabilities--such as the bad debts of the state banks, the unfunded state pension system ($600 billion), and social welfare liabilities--are factored in, the figure quickly rises to nearly 100 percent of GDP. The nonperforming loan ratio in China's four largest banks alone--the Bank of China, China's Commercial Bank, the Agricultural Bank of China, and China's Construction Bank--is officially pegged at 30 percent of total assets, but many believe the true level to be closer to 50 percent. Even at 30 percent, however, China's banking system is bankrupt. Nonperforming debt is estimated to be half a trillion dollars, but if one counts China's rural credit cooperative banking network, nonperforming debt doubles to a figure that matches or even exceeds annual GDP.

The Chinese have failed to make the transition to a modern economy, notwithstanding all the changes in recent years. China remains a gigantic company town. The government owns the biggest banks and companies. Some 300,000 state-owned enterprises employ nearly half of all China's workers. The big banks lend to these companies, which receive two-thirds of all loans yet produce only one-third of all output. The regime absorbs the losses. The system is dysfunctional and money-losing.

Chinese leaders know that their only hope is to grow their way out of the hole they are in by phasing out the money-losing enterprises, selling off their debt, and phasing in the money-making enterprises. This process would take decades under the best of circumstances, and the Chinese are hesitating. In fact, Beijing recently prohibited large state-owned enterprises from declaring bankruptcy, one of the principal ways of liquidating money-losing companies. This decision is a strong indicator that the regime is further slowing economic reform in favor of warding off social unrest.

China needs capital and cannot raise enough domestically by increasing taxes, which it is doing at all levels, including on foreign enterprises, or expanding domestic demand through the sale of bonds to the people. The Chinese bond market is deformed by government control of interest rates, and the equity market is plagued by fraud, insider trading, and stock manipulation. In fact, Beijing recently suspended sales of shares owned by the government, reversing a policy begun earlier this year to raise funds for the bankrupt pension system.

The share sales are crucial to Beijing's market reform campaign. The government owns 70 percent of all shares outstanding in the Chinese stock market. The suspension of new share sales immediately boosted prices of existing shares in Shanghai and Shenzhen, but it comes at a stiff cost. It cuts off an important avenue of financing for the national pension fund designed to support tens of millions of unemployed people nearing retirement age who have no medical insurance or savings.

The Chinese also turn to our capital markets to raise money, but this is coming to an end. We cannot permit the Chinese to exploit our own financial system against us, and we have begun to tighten up by enforcing strict registration requirements, insisting on transparency, and requiring full disclosure. We are also gradually curtailing indirect access to our markets, such as by listing on the London stock exchange and selling to so-called qualified international buyers in the United States. And we are gradually uncovering the PLA hand in many ostensibly commercial Chinese companies operating in the United States.

China believes that it can foist its debt onto us. In the past 2 years, China created four asset management companies (AMCs), then shifted 1.4 billion ren min bi in state-owned enterprise debt from the books of the big four banks to the AMCs, which have sought to sell off to the West. Not surprisingly, there are few takers. Questions regarding legal rights foreign investors would have over land and other assets combined with China's less than transparent policy environment have frightened investors away. If the AMCs cannot find buyers for this debt, which they probably will not, the state itself will be saddled with the interest due on the bonds.

On top of all this will come the costs of entry into WTO, which will either transform China into the golden goose, as many Americans claim, or be the poison pill that kills it. The gap between rich and poor is now the largest in the world and far and away the largest since 1949. The urban economy seems robust, but the countryside, where 900 million people live, is mired in debt and inefficient farming practices. WTO impact on China's agriculture will be devastating. Already 120 million people are estimated to be living below the poverty line, and 150 million more are seasonally employed migrant workers. The countryside is a tinderbox waiting for a match, which may be the WTO.

WTO will effect a transformation of the countryside, but things will get much worse before they get better. China's agriculture sector is the weakest link in the entire economy, and farmers will be hit hardest by WTO entry at a time when rural incomes are falling and infant mortality rates are rising. Resistance is already strong; riots and demonstrations are frequent, especially in opposition to the heavy hand of government tax collectors. The Chinese will be damned if they conform to WTO rules and damned if they cheat. Enforcement will only raise the level of conflict, while the refusal to do so will confirm predictions that the Chinese are out to manipulate the world organization.

The Chinese have made a major mistake in showing their hand too soon, mounting a premature challenge to the United States in the Far East on the pretext of action against Taiwan. That challenge is based upon an economic system that is still too weak and dependent upon the very power being challenged to succeed. The United States can and must begin to curb Chinese ambitions by raising their costs of doing business, reducing their revenues, and building an unchallengeable military position. Furthermore, we must do this now before China becomes too strong to control and we find ourselves on the path to war, which will be the inevitable outcome of the continuation of current policy. Fundamentally, it is not up to them. It is up to us. The fate of the Far East, and more, is in our hands.