China and its Discontents

The driving force behind the U.S. deficits and China’s surpluses lies not in exchange rates but in structural factors that built up over time. Three factors largely explain the emergence of China’s trade surpluses: surging U.S. consumption that fueled import demand, maturation of the East Asian production sharing network centered on China, and ratcheting up of China’s savings rates.

The story of the origins of the decline in U.S. household savings rates which was then exacerbated by growing fiscal deficits and together led to the excessive demand for imports is well known and still unresolved. This part of the story has little to do with China, but reflects the political gridlock in Washington.

Yukon Huang, of the Carnegie Endowment and former country director at the World Bank, writes at The Diplomat that the U.S. “must get over” the renminbi. While it is true that China gets the low-added value side of the production chain, and that if counted properly, our trade deficits with Japan, South Korea, et al would be much higher, I think he discounts the role of Chinese state policy in perpetuating the trade deficit. The Chinese, in effect, have subsidized our consumption: all dollars that flow into export businesses must by law be surrendered to the People’s Bank of China, which then invests it right back into U.S. treasuries because it doesn’t know how to spend its money fast enough (there are already questions about the quality of the infrastructure investments China has made). This is one of the primary reasons why the Chinese savings rate is so high–because it’s Chinese state policy. Sure, the average consumer has a high savings rate because of the volatility of the Chinese market (no social security/safety net, very few safe investments so much of those savings flows into real estate or low-interest savings accounts that don’t keep up with inflation–financial market liberalization is a topic for another day). But state-enforced savings far outweigh consumer savings. This investment in Treasury bonds, in turn, aids the U.S. in taking out more debt, and ultimately, for U.S. consumers to buy more things. It’s a vicious cycle of consumption.

Huang does give the right solution, however: increased Chinese consumption. But again, he seems to think this is mostly solved by individual consumers buying more things. He does suggest the Chinese state do one thing: relax the hukou residency permit rules, so that migrant workers can feel more secure in spending more money. This is all well and good (the Chinese hukou system is draconian; the lack of labor mobility is a huge drag on the Chinese economy), but the Chinese state can do a lot more: by spending more of the money it puts into Treasury bonds! If it’s having trouble disbursing the money in the form of infrastructure investments, fine! Use it to create a viable social safety net and universal healthcare! Pay school teachers more! Invest in the Chinese people, rather than trying to build the next big infrastructure monstrosity that will fall apart in five years anyway.

Over an official lunch in late February, a top South Korean diplomat confidently told the American ambassador, Kathleen Stephens, that the fall would come “two to three years” after the death of Kim Jong-il, the country’s ailing leader, Ms. Stephens later cabled Washington. A new, younger generation of Chinese leaders “would be comfortable with a reunited Korea controlled by Seoul and anchored to the United States in a benign alliance,” the diplomat, Chun Yung-woo, predicted.

That is a bold prediction – and the Guardian (here and here) is much more direct than the New York Times in claiming this. I agree with Stephen Walt that in regards to China and North Korea, the embassy cables are much more of a wash than they are portrayed as (what an ambassador says to another ambassador is not necessarily the discussion the Politburo Standing Committee is having). Even assuming Kim Jong-eun or the military cabal is somehow incapable of successfully negotiating the power transfer, there would need to be some pretty astounding diplomacy for China to be comfortable with a unified Korea. The entire idea behind supporting a divided peninsula from China’s perspective is that, regardless of how odious the North Korean regime is (and it is a serious headache to China), any unbalancing of the status quo will ultimately hurt China’s interests. Any US or NATO military presence above the DMZ and the floods of North Korean refugees, as the article notes, would be untenable. But that’s not all.

An ascendant, unified Korea could not be a benign ally of the US, according to certain Chinese viewpoints. Already, China is boxed in on all sides by countries closely-partnered with the US: South Korea (of course), Japan, the Philippines, Indonesia, Australia, and India. Unification means a great deal psychologically. A unified Korea would have subtle, but greatly-expanded persuasive powers on the international stage. I hope that, as the Guardian suggests, younger leaders are no longer concerned about this, and want to work with both Korea and the US in a mutually beneficial manner. But that’s not a given.

The goal, then, is to make unification in China’s interest. China might not be able to prevent it – the regime might slide so quickly as to be unsalvageable (and China certainly is never going to war over North Korea again). But the US and Korea should want China to recognize the unified state on its own terms. Not consulting the Chinese would harm our relations with them on all fronts. Incentives for Chinese investment in Korea would help – so would significantly paring back American military presence on the peninsula. (Why, in a post-North Korean world, would we even need military bases there? Is war with China a realistic threat in this day and age? And besides, we always have Japan) We could even couple some of the things China wants with some of our own priorities (on trade, fiscal policy, climate change, energy policy, you name it). I have a feeling that this is not a zero-sum negotiation in which China and the US negotiate, tit-for-tat. Instead, an outcome in which both sides are satisfied can only be positive.

I’m having a hard time imagining how painful the reunification process would be. The North Korean state, if it did merge with the South, would probably go down in flames. The state is already a wreck with food shortages and the like, but without even minimal state assistance many more would probably starve. The military would suddenly be a loose cannon – and the nuclear material currently lying around Yongbyon would be up for grabs. Of course, South Korea and the United States have certainly drawn up coordinated response plans to rush into the vacuum when needed, and have practiced plenty of military scenarios (the current exercise with the two countries’ navies being conducted right now included). But it still boggles the mind.

From Steve Clemons:

Information has reached me that some USAF personnel have been put on 24 hour deployment alert with regard to North Korea. I don’t know how regular or irregular that is — but know that despite a lot of tension in the country since 9/11, my sources have not been put on such alert before. The USAF has denied that it has changed its alert status in comments to other journalist friends of mine — but the actual personnel beg to differ.

When I first heard the news that North Korea had shelled an island across the DMZ, I thought this disturbing provocation seemed more serious than previous attacks. Let’s hope this does not escalate.