East of Suez: A British Strategy for the Asian Century. Part Three: China

Young Fabian, Ash Dharmasingham writes on British strategy in Asia. Over the next few weeks we will be publishing his research into this important issue. This week's topic is "China". Follow our blog to read next week's piece on Japan

Analysing China's Rise

In order to devise a British strategy for China, it is important to first understand the Chinese mind-set, and analyse China’s intentions and actions. According to Kissinger, China is characterised by cultural exceptionalism based on the pre-colonial Sino-Centric order where it saw itself as ‘the Middle Kingdom’ at the top of the political hierarchy, surrounded by lesser tributary states  (Kissinger, 2011, pp.xiv, 3, 10). As late as 1820, China produced over 30% of global GDP - which exceeded Europe and the US combined. Kissinger believes that this traditional context must be understood in order to understand China in the 21st century (Kissinger, 2011, pp.3, 12).Under Zemin, China’s National Patriotic Education Campaign pushed a nationalist narrative that detailed how colonial powers humiliated China in the ‘Century of Humiliation’. Britain’s role in the “unequal treaties” is included and while this is not seen as bad as Japan’s actions in china, according to Brown, the nationalism resulting from the education campaign, “does impact on views of Britain in China today” (Brown, 2016, p.35). Over the past few decades, China has demonstrated a phenomenal rise to power. In 1978, China’s GDP was small (ranked 17th in 1979), it “exported and imported next to nothing” and the vast majority of people were employed in Agriculture upon which the economy was centred on (Brown, 2013, pp.101, 103-104). Chinese GDP growth has averaged 10% a year since 1978 and by the early 2000s, China had in the words of Zhu Rongji, become “the factory of the world”. China is now the world’s 2nd largest importer and largest exporter with services and industry making up 90% of the economy in 2011 (Brown, 2013, pp.101, 105). Furthermore, China overtook Japan as the world’s second largest economy in 2010, overtook the US as Africa’s primary trading partner in 2009 and has also overtaken Russia “as the main economic partner of the former Soviet republics in Central Asia” (Christensen, 2014, pp.14, 18, 19).

China has undoubtedly risen to great importance although there is debate as to whether China’s rise will be benign or a threat. Liberal internationalists such as Ikenberry and Slaughter believe that China like the US is a status quo power that has a strong interest in the maintenance of the international order as it benefits them (Rachman, 2016, pp.49-50). Bader writing before the Xi Jinping era, believes that whilst frictions are “bound to arise” between the US and China due to large differences in “histories, cultures, interests, and values”, major conflict is unlikely since China does not have the same expansive tendencies that once characterised Germany, Japan and the Soviet Union (Bader, 2012, pp.144-145). China has also engaged multilaterally with organisations such as the Association of Southeast Asian Nations (ASEAN) (with which it enacted a free trade agreement in 2010) as well as founding the Shanghai Cooperation Organisation and helping found the East Asian Summit (Christensen, 2014, pp.22-23). China, according to Christensen, has also become much more active in the UN during the last two decades, and has become the largest contributor of peacekeeping forces of all five permanent members of the security council (Christensen, 2014, p.25). Such examples show evidence that China can and will be integrated into the rules-based order although it must be noted that China in the past several years has threatened or used vetoes against “draft resolutions aimed at Sudan, Burma, Zimbabwe, and Syria”. This has led Christensen to argue that whilst China has embraced multilateralism, it has not gone so far to “wholeheartedly embrace the newest multilateral efforts to create global governance by supporting active enforcement of new international concepts such as ‘the responsibility to protect” (Christensen, 2014, p.25).

Other academics are much more pessimistic. Graham Allison warns of a ‘Thucydides trap’ arguing that “rising powers have gone to war with established powers on twelve out of sixteen occasions since 1500” while Mearsheimer believes that China would build “a mighty military machine” and seek regional hegemony (Rachman, 2016, p.37); (Jones et al, 2013, p.43). Jones, Khoo and Smith point out that economic interdependence seems to have had little effect on China during times of nationalistic fervour when nationalistic and political factors provide a better explanation for Chinese foreign policy, mentioning the Taiwan Straits Crisis of 1995-96 when the US 7th Fleet had to intervene to deescalate a dispute despite economic interdependence between China and Taiwan.

Zheng Bijian argues that China wishes for a peaceful rise and that it wants to focus on economic development in order to become a modern nation rather than violently pursue hegemony (Bijian, 2005). Chinese strategy is said to be based on Deng’s 24-character strategy - “remain cool-headed to observe; be ready to react; stand firmly; hide your capabilities and bide your time; never try to take the lead; and be able to accomplish something” (Brown, 2013, p.167). It is unclear if this suggests that China wants to rise peacefully or if China wants to eventually strive for hegemony once it is strong enough.

An increasingly confident and assertive China under Xi Jinping arguably suggests the latter. This was for instance seen in Jinping’s choice for State Councillor (China’s top foreign policy role), Yang Jiechi who unlike his predecessor, Dao Bingo did not endorse theories of peaceful rise advocated by those such as Wang Jisi, and was seen to be more aggressive. For instance, at a summit in Vietnam for Asia-Pacific nations, when talking about territorial disputes, he stated, “China is a big country. And you are all small countries. And that is a fact” (Rachman, 2016, pp.50-51). Just a month after Xi Jinping took over, in December 2012 Chinese aircraft entered Japanese airspace for the first time since 1958. Then in November 2013, China declared an Air Defence Identification Zone (ADIZ) over most of the ECS that overlapped with South Korea’s and Japan’s ADIZs. (Rachman p51) As Christensen argues, a growingly more militarily and economically more powerful China combined with rising nationalism puts pressure on political elites to be more assertive and aggressive internationally (Christensen, 2014 pp.29, 258, 260). China’s growing economy offers many opportunities for engagement to Britain but on the other hand, China’s increasingly aggressive actions are a cause for concern since they harm both the interests of Britain and those of the rules-based order. Britain must, therefore, adopt a strategy of measured engagement with China that could show firmness when needed.


Sino-British Economic Engagement

One of the most potent areas of engagement and opportunity for Sino-British cooperation and prosperity is in the internationalisation of the RMB. The RMB was previously a non-convertible currency which could not easily be used to settle invoices overseas or traded against other currencies in global currency markets. According to Brown, the RMB had to be bought in the country itself and Chinese exporters, in theory, had to exchange their foreign currency for RMB via the central bank (although in practice may offshore their currency through Hong Kong etc.) (Brown, 2013, pp.125-126). Such capital controls resulted in the undervaluing of the RMB (making Chinese exports cheaper) and the accumulation of large foreign exchange reserves that China then invested in US treasury bonds. This served to keep the excess money out of the Chinese economy. This ensured that inflation was kept low despite an undervalued RMB. Cheap Chinese exports combined with money flowing back to the US allowed more Chinese goods to be purchased and high export-led growth for China (Seth, 2017).

These capital controls have attracted a lot of criticism, particularly from the US, whose former Treasury Secretary has accused China of being a “currency manipulator” (Jones et al, 2013, p.27). Since 2009, however, China has been attempting to make the RMB an international reserve currency by promoting its use in international trade and creating an offshore market in international financial centres for RMB-denominated assets, consequently creating increased circulation and liquidity in international markets (Subacchi and Oxenford, 2017, p.3) Such actions may lead to the RMB appreciating in value and thus more expensive exports but it would also help Xi Jinping create a Chinese financial sector centred in Shanghai, and lead to greater Chinese purchasing power helping China transition to a more service sector economy as desired (Brown, 2016, p.56). It will also help China finance its One Belt, One Road (OBOR) initiative which is a series of investment commitments that aim to connect China to Europe “via land links along the ancient Silk Road through Eurasia” and, South and Southeast Asia “via improved port and maritime facilities” (Dongmin et al, 2017, p.16); (Subacchi and Oxenford, 2017, p.3).

Britain currently has a great opportunity to make London the most important international financial hub for the RMB. Although between 2013 and 2014 the RMB rose from the 13th to the 5th most traded currency in the world, it still only constitutes 4.4% of global payments (Brown, 2016, p.55). London offers many great advantages to China and can further help internationalise the RMB. London is “the largest, most liquid and most international market outside the US”, has a huge catchment area in Europe and is also less political than markets in the US (Brown, 2017). Additionally, it has a vast and sophisticated financial centre that offers high capital volumes, deep liquidity, strong regulation, a large and diverse pool of international investors, and offers conformity with international accounting and reporting standards (Brown, 2016, p.56); (Subacchi and Oxenford, 2017, p.2). Furthermore, London is “almost perfectly placed between the close of China’s market and the opening of those in the US”, giving it a time-zone advantage (Brown, 2016, p.56). London is therefore arguably the best financial centre for the task of internationalising the RMB.

This opportunity is important to Britain as it helps strengthen and preserve the UK’s financial services industry. Since Brexit may result in decreased European demand for British financial services, it is increasingly important for Britain to seek other markets such as China (Dongmin et al, 2017, p.15). Brown believes that if Britain succeeds in its efforts, it will secure “a major strategic role” with China and “a key point of leverage”. In his view, this could lead to successes of other more “politically-charged” areas such as “the environment, security and political dialogue”. He also believes that it could create new partnership opportunities with European states with strong financial markets as well as the US (Brown, 2016, pp.66-67). It is no surprise therefore that between 2011 and 2014, foreign exchange trading in RMB in London increased 20-fold, and that London has surpassed Singapore as the second largest city for payments handling 6.3% of all RMB-denominated payments (Brown, 2016, pp.54-55); (Subacchi and Oxenford, 2017, p.7). London, however, lags behind Hong Kong, which accounts for 73% of payments. Furthermore, London is behind Hong Kong, Taipei, and Singapore when it comes to liquidity (Subacchi and Oxenford, 2017, p.7).

There are several things that Britain can do to make London the leading RMB trading centre. Since Britain is very experienced in project financing, the government working with the financial and legal services could develop a market for RMB project finance in London to promote OBOR. This could be very successful since OBOR could help reduce a huge infrastructure investment gap in Asia which is estimated by the Asian Development Bank to be around $730 billion by 2020 (Dongmin et al, 2017, p.13, p16). London could also issue Chinese local government bonds, promoting the RMB as an international reserve currency and increase London’s RMB asset pool (Dongmin et al, 2017, p.18). Britain must, however, be careful, in the risk it takes to internationalise the RMB, for instance in 2014, Britain agreed to “establish a sovereign offshore bond in RMB to finance UK reserves” (Brown, 2016, p.55). Such a move entails a degree of currency risk. Since Britain’s currency floats freely against the RMB, a fall in Sterling against the RMB would mean a higher Sterling-denominated debt repayment for a bond denominated in RMB.

 

Another form of economic engagement that the UK government has been particularly keen on especially during the Osbourne-Cameron ‘Kowtow to China’ saga in 2015, is attracting Chinese investment in the British economy. China is expected to be a net exporter of capital by 2020 and Britain due to its consistent legal and regulatory systems, talent and capital markets is an attractive place to invest (Brown, 2016, p.59). Furthermore, unlike the US Committee on Foreign Investment and the Australian Foreign Investment Review Board, the UK does not have similar powerful, bodies of scrutiny for foreign investment. Investment simply needs to be in line with local financial laws (Brown, 2016, p.58). Several deals have been made with the Chinese such as investing in a British nuclear power station (Hinkley Point C - £2.6 billion) which is claimed to create 25 000 jobs and a joint venture between Alexander Dennis and BYD (£2 billion) expected to safeguard 2100 jobs (Nelson, 2015); (Brown, 2016, p.62).

 

The Need for Firmness in Sino-British Relations

The nature of British engagement of China under Cameron and Osborne, however, has been heavily (and justifiably) criticised. For instance, despite the fact that the British steel industry was at risk, the UK according to the European Steel Association led the blocking attempts to impose tariffs like the US has done on Chinese steel, which were being dumped on Europe via China’s controversial steel export tax rebate (Kollewe, 2016); (Perraudin, 2016). Such a state of affairs also does not help the government’s perception of London-centricity. Additionally, China has been criticised for displaying a lack of a “level playing field” when it comes to foreign investment. Michael Clauss, the German ambassador to China, for instance, has criticised a series of Chinese measures discriminating against foreign companies like the tendering process in the high-speed railway sector which actively discriminates against foreign companies. The ambassador has claimed that instead of progress in market access, there are further restrictions being implemented like the planned requirement of all food products to have import certificates even though international standards only require it for high-risk food (Wu, 2016).

Moreover, there have been several security concerns about Chinese investment into Britain’s CNI. Huawei’s involvement in Britain’s telecommunications is one such concern. Although Huawei is a non-state company, the Chinese state is heavily involved in telecommunications and as such, many are suspicious of Huawei (Brown, 2016, p.21). Moreover, a British Intelligence and Security Committee (ISC) report noted that 20% of detected cyber attacks against British interest demonstrate levels of sophistication that can only be attributed to state-sponsored attacks. China is suspected to be one of the main perpetrators of such attacks (Parliament, 2013). Huawei attempted to bid for large contracts in the US, the US House Intelligence Committee accused it of “cyber-espionage” and labelled it a “security threat”. Similarly, the Australian government prevented it from tendering for the construction of the national Broadband Network. Despite these fears, and despite the fact that British intelligence officers in 2009 labelled the company a serious threat, Huawei has been able to operate more easily in the UK (Brown, 2016, p.21). A 2013 ISC report was however deeply critical of Huawei and the government’s handling of the case, arguing that putting national security at risk in such a way was “unacceptable”, that ministers were being “unsighted on an issue of national importance” and that immediate action had to be taken to prevent something like that ever happening again (Parliament, 2013, p.20). Given the reservations of the ISC, allied governments and the British intelligence community, it is highly perplexing and deeply unsettling that the government decided to risk Britain’s CNI in order to please the Chinese.

Another case of concern is the previously mentioned Hinkley Point deal and potential future Chinese involvement in Britain’s nuclear energy industry. By controversially allowing the Chinese to first invest in Hinkley Point C and then potentially allowing further reactors that would be designed and built by the Chinese, Britain would be putting the CNI at risk. One must also note that the Chinese are not known for their expertise in the nuclear energy industry (West, 2016).China’s increasing hold over the energy sector concerned Lord West. He was also anxious about Huawei, and the fact that the Chinese have taken over the largest data centre in the UK and the largest CCTV and security organisation in Europe, and the threat this poses to Britain given that 4 PLA (People’s Liberation Army) have been actively conducting cyber attacks against British, American and European firms (West, 2016). Britain must, therefore, take a more hardened stance against Chinese involvement in the CNI.

Importantly, Britain’s soft attitude towards China threatens to isolate Britain’s allies particularly the US and Japan. One Obama administration official reportedly told the Financial Times that they are “wary about a trend toward constant accommodation of China”. The US was particularly troubled by the fact that Britain decided to join the Asian Infrastructure Investment Bank (AIIB), which is seen as a Chinese-controlled competitor to the World Bank (Nelson, 2015). In Britain’s defence, however, the AIIB offered an opportunity to integrate China into the international order and encourage it to play a constructive role in development. Britain would wield more influence over China and Asia within the AIIB than out of the AIIB (Brown, 2016, p.45).

There is no assurance that Britain’s soft attitude towards China would be worth the risks taken such as those to the CNI and relationship with allies and the sacrifices made, for example in the abandoning of the British steel industry. There is no guarantee that the RMB would establish itself as a major reserve currency and that the market would be centred in London. Furthermore, according to Wheatley and Subacchi, “China generally respects those who display firmness not weakness” (Wheatley and Subacchi, 2015). If Britain is to be respected and have any influence over China, it must show firmness. Theresa May, however, has arguably shown more of this much-needed firmness and seems to have taken a more appropriate and measured policy towards China. According to a Cabinet Office official, the current administration has a more “hard-headed view on how we work with countries like China” and has been reassessing the role of foreign government in our CNI (Cabinet Office Official, 2016). The fact that the government reviewed plans for Hinkley Point C shows that May is more cautious about China (Bew, 2016-a).

China and the International Maritime order

 

Item 1: The Nine-Dash Line

Britain needs to be more firm in the SCS. In recent years, China has been undertaking actions that threaten the international maritime order and regional stability, particularly in the SCS. China for instance unrealistically claims a vast proportion of the SCS based on an ancient map that apparently marks out Chinese territory in the SCS along a Nine-Dash line [Item 1]; (Phillips et al, 2016). This was further affirmed by the Philippines vs China case at the Permanent Court of Arbitration at the Hague in July 2016 which ruled overwhelmingly in favour of the Philippines and effectively refuted China’s 9-dash line claims (Phillips et al, 2016); (Christensen, 2014, p.257). Furthermore, China under Xi Jinping has been trying to strengthen such claims through a large-scale island-building programme of land reclamation and dredging that aimed to turn sea-shoals into small islands (Rachman, 2016, p.54). China has also been militarising many of the islands in the SCS especially the Spratly and Paracel islands with fighter planes, anti-ship cruise missiles, anti-missile defences and other equipment and facilities (Panda, 2016-b); (Sherwell, 2016); (Phillips et al, 2016). Additionally, in July 2012 China provocatively formed a new government administration - ‘Sansha City’ under Hainan Province which claims jurisdiction over large parts of the SCS including the Paracel Islands, Spratly Islands and Macclesfield Bank (Christensen, 2014, p.262). China has also undertaken more direct forms of provocative actions such as blocking the mouth of Scarborough Shoal’s Lagoon, preventing all access to Filipino ships after the Filipino navy arrested Chinese fishermen allegedly hunting an endangered species of clams in disputed waters (Christensen, 2014, p.260).

Significantly, China has a different interpretation of a number of provisions under the United Nations Convention on the Law of the Sea (UNCLOS), with which only a few states agree. For instance China has a more restrictive view on what activity is permissible in a state’s Exclusive Economic Zone (EEZ) and maintains that the ‘freedom of navigation’ (FON) and ‘right of innocent passage’ through a state’s territorial sea does not extend to military vessels (Ku et al, 2016); (Jones et al, 2013, p.29). Chinese actions, therefore, challenge the established international maritime order and increases regional instability.

The US in response have been leading FON operations which contest China’s assertiveness in the SCS and aims to protect the right of innocent passage (Ku et al, 2016). The US’s efforts would be strengthened if more nations joined these efforts. In December 2016, the British ambassador to the US hinted that due to FON concerns, Britain may join FON operations in the future and will deploy the carriers to the Pacific once operational in the 2020s (Brunnstrom, 2016). Britain should do so. As established, the SCS is of great importance to Britain given the amount of British and international trade that passes through the area. Patalano believes that China’s building of artificial islands and increase in military footprint in the SCS poses a problem for a lot of regional states as well as Britain due to the importance of the SCS to world shipping. In his view, it “creates an implicit political lever for Beijing to be used with subtle moves, coercion [and] threats” which challenges the maritime order (Patalano, 2016). Peter Roberts goes further and argues that if FON is closed down in the SCS, British trade in the SCS would be “subject to laws, boarding, potentially tariffs from China, that sit outside the international system” that would “break with every part of the international relations model for trade” that currently exists, setting a dangerous precedent for intervention in ungoverned spaces which would harm British trade, security and prosperity. He, therefore, believes that Britain should join FON, arguing further that Britain as an upholder of Liberal Democratic values must undertake actions that demonstrate these beliefs rather than simply talking about it (Roberts, 2016). Lord West believes that China would not impose tariffs on international shipping but would eventually claim the entirety of the SCS as its EEZ, causing tensions with neighbours and potentially disallowing the right of innocent passage. West too strongly advocates Britain exercising the right of innocent passage in the SCS (West, 2016).

It could be argued that a more firm posture from Britain in regards to Chinese actions in the SCS could lead to Chinese reprisals, potentially damaging trade relations. The US’s decision to deploy the Terminal High Altitude Air Defence (THAAD) system to South Korea, has resulted in China directing local travel agencies to stop selling packages to South Korea, affecting the South Korean tourist industry (Lee and Kim, 2017). In the grand scheme of things, however, these penalties were not significant given how dependent the South Korean economy is on China. Similarly, when the Norwegian Nobel Committee awarded the Peace Prize to Liu Xiaobo, a Chinese dissident, Beijing only subjected Norway to symbolic sanctions (Baker, 2016). Chinese penalties (if any) on British firmness are unlikely to be severe and only symbolic. Indeed when China imposed a symbolic diplomatic freeze on Britain after Cameron met with the Dalai Lama, China continued to trade with Britain and invested in Thames Water and Heathrow Airport during the freeze (Brown, 2016, p.60). As Lord West argues, it is “crucially important” that states stand up for the values that they believe in such as international law, freedom of the commons, freedom of speech etc and “whilst there’s always a bit of a balance in Realpolitik, when push comes to shove, those things are more important than a trade deal” (West, 2016).

 

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