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Willem van Kemenade Willem van Kemenade Website: Website: www.willemvk.org

E-mail: kemenade@xs4all.nlE-mail: kemenade@xs4all.nl

THE EU-CHINA-US THE EU-CHINA-US GRAND TRIANGLE GRAND TRIANGLE

How to balance Strategic Rivalries and How to balance Strategic Rivalries and Commercial Interests Commercial Interests

Vlerick Leuven Gent Vlerick Leuven Gent Management School Management School

October 17, 2005 October 17, 2005

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ContentsContents

China’s domestic political, social and economic development

The Trans-Atlantic Rift America’s Hard and Europe’s Soft

Power M&A, Sanctions Free Trade vs. Protectionism

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Hu Jintao (61), the smiling Hu Jintao (61), the smiling Closet Hardliner Closet Hardliner

Since take-over in 2002-2003, hope was high that Hu would introduce a new wave of political reforms. However, he has suppressed the debate at the national level and revealed himself as a stern leader, focussing on rural poverty, government austerity and anti-corruption.

Worried by people’s power take-overs in Ukraine, Georgia and Kygyzstan and rebellion in Uzbekistan, there is a crackdown on dissent: arrest of writers and journalists, tougher controls on the Internet and foreign media, tighter police surveillance of activists, a clampdown on NGO’s.

As state control over the economy declines and the private sector expands, Hu want to re-centralize state- and party-power so as to maintain stability and order.

In foreign policy Hu stresses “Peaceful Rise” rebuking the US Neo-Cons and Japanese right-wing, who see China as a “Threat”.

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The World’s 15 Largest Economies The World’s 15 Largest Economies 2002-20032002-2003

GDP* Population1 United States 10.065 2852 Japan 4.141 1273 Germany 1.846 824 United Kingdom 1.424 595 France 1.310 596 China 1.159 1.2727 Italy 1.089 588 Canada 694 319 Mexico 618 9910 Spain 582 4111 Brazil 502 17212 India 477 1.03213 South-Korea 422 4714 Netherlands 380 1615 Australia 369 19

Source: World Bank Atlasses, 2003-2004 The Economist, Pocket World in Figures

2005

* Billion US$ ** Billion €

GDP* Population1 United States 10.383 2882 Japan 3.993 1273 Germany ** 2.108 824 United Kingdom 1.566 605 France ** 1.521 606 China 1.266 1.2947 Italy ** 1.258 578 Canada 714 319 Spain ** 694 4010 Mexico 637 10211 India 510 1.04112 South-Korea 476 4713 Brazil 452 17514 Netherlands ** 444 1615 Australia 409 19

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The World Economy is The World Economy is booming in Chinabooming in China

Sixth largest economy, second in PPP; 4th trading power. 22 % of the world’s population; GDP of $ 1.55 trillion is 4 % of the

world aggregate of $ 36 trillion. Per capita income 2004 $ 1.196,--. China is expected to match the US in coming decades as the

“locomotive of world economic growth”. It now contributes 18 % to global growth. In 2003 China accounted for 60% of world trade growth

"China's economy has continued to depend too much on externals," . About 45 % of China's growth derives from exports, and so the

country's economic health is highly vulnerable to protectionist pressures from the US and Europe.

"Exports are becoming a growth engine, but China will have to carefully deal with these external risks."

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The Yuan: From Dollar The Yuan: From Dollar Peg to A Managed Peg to A Managed

Floating Exchange Rate Floating Exchange Rate RegimeRegime

After a long campaign of pressure and threats from the US, China, on July 21 revalued its currency by 2.1 % and re-pegged it from the dollar to a trade-weighted currency basket of dollar, euro, yen and won. Yuan is permitted to fluctuate 0.3% daily, which in theory allows the yuan to creep up, however, central bank intervention makes a dramatic appreciation unlikely.

The US had demanded at least 10 % but welcomed this as a “good first step”. China has categorically stated that there won’t be any more adjustments.

A substantial revaluation would heighten the risk of a massive exodus from real estate, as speculators look to cash in, pushing the shaky banking sector into a tailspin. Huge amounts of property would hit the market and real estate prices would go into a tailspin.

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Foreign Foreign Investment Investment

China attracted a record $60.6 billion in actual FDI in 2004 as major overseas retailers, auto makers and other manufacturers ramped up spending.

Foreign investment during the first half of 2005 fell 3.2 % as falling prices and rising costs prompted global manufacturers to cool expansion in the world's fastest-growing major economy.

China still attracted more than five times as much foreign investment as Southeast Asia last year and almost 14 times more than India, according to Asian Development Bank figures.

The top 10 places of origin: Hong Kong, British Virgin Islands, Bermuda, Japan, S.-Korea, US, Taiwan, Singapore and Germany.

FDI numbers are problematic, since no one really knows the extent of round-tripping (i.e. Chinese money leaving the country and then re-entering via Hong Kong, BVI as fake or pseudo-investment in order to exploit tax advantages for foreign-invested enterprises).

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Trade Growth: Trade Growth: 2004 Volume exceeded $ 1.1 2004 Volume exceeded $ 1.1 trillion, but 2005 some slowdowntrillion, but 2005 some slowdown

Price hikes in raw materials and energy have made exports more expensive. During first half 2005, exports still grew by 32.7 % to $ 342 bn but import growth plunged to 14% to $ 302 bn.

China's fastest export growth has been in metals from the smelters that Chinese investors eagerly financed in recent years: Steel exports grew by 208 % in value in the first five months of this year, while aluminum exports grew 64 %, according to Chinese customs statistics.

China consumes a third of growth in global oil demand, imports half the world’s demand for cement, a third of steel, a third of copper and a quarter of aluminum.

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Some Slowdown in Foreign Trade Growth Some Slowdown in Foreign Trade Growth

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1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005*

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Exports b$

Imports b$

Growth %

Source: Mofcom

Chinese exports doubled in just over five years. In contrast it took British exports 12 years to double in the 1840s, Germany ten years in the 1960s and Japan seven years in the 1980s.

* First Half

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When will China’s Economy When will China’s Economy be bigger than the US’s ?be bigger than the US’s ?

In 2003 China's GDP was $1.41 trillion and America's was $11.26 trillion. At constant, average growth rates of 8 % for China and 2.5 % for the US, China would have a bigger economy in 2043.

Current demographic forecasts suggest that China's population will peak around 2050 and then start to decline. Well before that, say 2030, it will be demographically one of the oldest countries in the world, with a very high retiree-to-worker ratio.

Various imponderables – political crisis, effect of climate change, war, may lead to different outcomes.

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Regional Relative Weight in the Regional Relative Weight in the World EconomyWorld Economy

Europeans are recognizing that in terms of economic muscle and trading influence, the world is rapidly coalescing into three blocs: America, Greater Europe, and a China-centered Asia.

East Asian countries, including China, account for 54 % of Japan's GDP.

In comparison, Central Asian countries Kazakhstan, Kyrgyzstan, Tadjikistan, Uzbekistan, Turkmenistan, Afghanistan account for 5 % of China’s GDP.

Latin American countries account for 15 % of the United States' GDP.

East Europe accounts for just 8 % of the EU's GDP.

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China: A Regional Power with some Global Influence China: A Regional Power with some Global Influence and the Ambition to become a Two-Ocean Countryand the Ambition to become a Two-Ocean Country

Gwadar

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A China-Centred WorldA China-Centred World

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A Europe-Centred World A Europe-Centred World

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Trans-Atlantic Rift Trans-Atlantic Rift over Chinaover China

China expressed its desire for a “strategic partnership” with the EU in its first EU-policy paper in October 2003, when anger over the war in Iraq had just reached its peak in Beijing and several European capitals.

One of China’s demands was the lifting of the EU arms embargo, imposed after the bloody repression of 1989.

The EU linked the lifting to improvement of the Human Rights situation in China but during 2005 it became evident that American opposition and threats were the main reasons for EU wavering.

The US views China as its main future adversary, whereas Europe sees China as an emerging pole, that together with a more cohesive future European Union will give shape to a multipolar world, to replace a US-dominated unipolar world.

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Escalation of trans-Atlantic rift Escalation of trans-Atlantic rift over the Lifting of the Arms over the Lifting of the Arms Embargo during 2005Embargo during 2005 US rhetoric: “Immoral Europeans making fast bucks by

selling arms to Communists to better kill Americans, defending Taiwanese democracy”.

The issue had become entangled in how the hardline China-bashers in Congress perceive China.

The House of Representatives on July 14 rejected the “East Asia Security Act” giving the president the authority to bring sanctions against European companies that would sell arms to China.

The US arms industry had strongly lobbied against the legislation, because more export controls would result in unspecified American job-losses.

EU businessmen didn’t expect that lifting the embargo would result in quick, big arms deals but would facilitate other high profile deals such as the Airbus A 380.

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Shift in Global Strategic Culture Shift in Global Strategic Culture

Several developments are changing the psychology of global strategic relations:

The decline in American power and prestige as a result of:– The bungling of the war in Iraq;– The bungling of aid and rescue during Hurricane Katrina;– The inability of the US to impose its will on Iran;– US failure with North-Korea and the indispensability of China to

solve the North-Korea problem. The Rise of China and the emergence of a “comprehensive

strategic partnership” with the EU has made the US realise that it cannot exert too much influence over the future of China.

The vehement row over the lifting of the arms embargo has led to tentative trans-Atlantic steps how to jointly deal with China, the most momentous question of our time

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Why Different European and American Why Different European and American Approaches towards China ?Approaches towards China ?

Unlike the US, Europe doesn’t have military alliances, troops and navies in East Asia - Japan, S.Korea, Taiwan (?) European involvements are mainly trade, investment and soft power.

The US Right is obsessed by the determination to remain the pre-eminent military power and will not tolerate any challenger anywhere in the world throughout the 21st century (see: Project for the New American Century).

It is European policy to “socialize” China into the international institutional order by offering it the full range of assistance and collaborative programs.

American policy is ambivalent. Trade and investment are huge but aid programmes are mostly carried out by private foundations.

Government policy frequently shifts from engagement to confrontation and v.v.

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Rumsfeld to China for first time: Rumsfeld to China for first time: “Non-Euphoric Encounter”“Non-Euphoric Encounter”

Secretary of Defense Rumsfeld, the most outspoken anti-China hardliner will visit China this week.

China has actively sought the visit by Rumsfeld for four years. "The Chinese military wants this visit far more than the American military. Rumsfeld's reluctance to go to China is legendary," said one expert.

Rumsfeld asked to visit the underground military facility in Beijing known as the Western Hills Command Center, but the Chinese refused. Instead they will allow him to visit the “Second Artillery”, China’s missile forces.

"Secretary Rumsfeld goes there with the intention ofhaving some positive outcome," a spokesman said. "I don't think there's any particular breakthrough that we expect. Just his presence and a serious dialogue is worthwhile."

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Solana’s hardly veiled Criticism of the USSolana’s hardly veiled Criticism of the US

“Multilateralism and respect for international law are fundamental tenets of the EU's foreign policy. And I know the same is true for China. Together we need convince our other partners to put these principles at the centre of their foreign policy too.” (Speech at CEIBS, Shanghai, 6-9-’05).

Asked to compare China’s relations with the US and the EU, a senior FM official said: “Our relations with the US are candid, cooperative and constructive. Our relations with the EU are comprehensive, strategic – i.e. longterm, beyond ideology and not disturbed by minor issues – and a partnership, i.e. equality”.

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US: Security Threat First ~ US: Security Threat First ~ Business Second Business Second

Public discourse in the US concerning China invariably refers to its rise and is dominated by analysis of China’s increasing hard power, the growth in Chinese military power and its effect on U.S. national security interests in East Asia, both with respect to Taiwan and more generally.

Notwithstanding popular discontent over the loss of U.S. manufacturing jobs as a result of outsourcing to China, even China’s substantial economic prowess and trade surplus with the United States take a backseat in these debates to the national security implications of China’s rise.

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Europe focuses on the Europe focuses on the “Non-Traditional” Security “Non-Traditional” Security Threat of ChinaThreat of China

The strategic partnership between the EU and China, agreed to in 2003, reflects the European view that China has become a key player on the types of soft security issues that Europe considers significant.

The EU believes that the main threats to its security are of the transnational variety: illegal immigration, international crime, contagious diseases, energy, environment, and problems related to poor governance.

The EU views China as one of the major powers that will shape the outcome of these problems.

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Americans use the Americans use the Megaphone, Europeans Megaphone, Europeans the Telephonethe Telephone The United States is holding China to a higher standard than

others, because China is a divisive partisan issue in US domestic politics.

Its size, its impact on other major economies and the world at large are perceived as a potential threat in the U.S., more than in any other Western nation.

Indications are that the United States is prepared to confront China on the issues of Intellectual Property Rights and distribution- and trade rights this year and that the Europeans and Japanese will reluctantly support this approach.

Europeans accord priority to negotiating because they cannot impose their will on others anymore. The US has the sanctions approach – Section 301. As former European Trade Commissioner Pascal Lamy observed last year, Americans like to use a megaphone, we Europeans prefer the telephone.

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EU-China: More than TradeEU-China: More than Trade The EU has already become China's leading trade partner, and

China is the second-largest destination in the world for EU exports. But these statistics obscure the scope and depth of the EU-China dialogue.

The summit in Beijing in September bolstered an ever-deepening set of EU-China relations that includes work on a new and wide-ranging Framework Agreement to further formalize political relations; strengthened scientific and technology cooperation; collaboration on labor, tourism and migration issues; and a specific effort aimed at climate change and energy supply security.

EU-China cooperation on space is already far along, as China is a major partner in the development and deployment of the Galileo navigation system.

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Ninety Percent of the EU-China Ninety Percent of the EU-China Relationship is EconomicRelationship is Economic

China is now the EU's second-largest trading partner after the United States.

In 2004, EU-China trade grew to € 126 bn, or $ 163 bn, a 22 % increase from the year before. But trade between the two has been far from untroubled. Much of it is Chinese exports flowing to Europe, to the point that in 2004 the EU's trade deficit with Beijing ballooned to € 78 billion.

The EU has complained to China about inadequate protection of copyrights and patents, barriers to agricultural imports and services such as banking, and China's booming garment exports. European officials in Beijing stressed that the Union is generally satisfied with the progress of China's economic reforms and hopes to resolve disputes through negotiation.

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Europe’s Focus: Improve the Governance, the Europe’s Focus: Improve the Governance, the Legal System, the Business Culture of ChinaLegal System, the Business Culture of China

Europe views China’s rise in terms of its domestic transitions, i.e. a multiple transition from state socialism toward a market economy, a more open society, and a more representative and accountable government.

Unlike analysts in the US, who focus on China’s external posture, European analysts focus on China’s internal scene and want to assist China in managing its transition and reforms.

Europe does not want China to become a failed state. Unlike the US, Europe is more willing to accept China as it is.

Accordingly, the EU believes that it has a great deal to offer.This is the case not only because of western Europe’s own long experience with social democracy and the welfare state but also the ongoing East- European states’ experience as transitional economies and polities that have emerged from a similar period of state socialism.

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Opposition against Lenovo’s Opposition against Lenovo’s acquisition of IBM’s PC acquisition of IBM’s PC division for “phoney security division for “phoney security reasons”reasons”

The U.S.-China Economic and Security Review Commission wanted to derail the deal under the pretext that Chinese computer experts could conduct espionage from IBM facilities. Another complaint was that technologies that Lenovo acquired could have a "dual use" and enhance China’s military.

However, the PC business has become a low-margin commodity business, based on costs and efficient assembly and distribution more than on new technology. IBM sold this unit in part to focus its resources on higher-margin consulting and software.

By making Lenovo the world's third-largest computer maker, the $1.3 billion sale would draw China more tightly into global economic interdependence and raise the price of any Beijing aggression. A computer maker dependent on foreign markets will not want its country invading Taiwan.

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CNOOC’s Failed Bid for UnocalCNOOC’s Failed Bid for Unocal

China National Offshore Oil Corp (CNOOC) made a $ 18.5 bn bid this summer for a small US oil company Unocal, while Chevron made a rival bid of $ 16.8 bn.

Anti-China hysteria in Congress poisoned and killed the deal: “China is pursuing a national strategy of domination of the energy markets and strategic dominance of the western Pacific.”

For China the deal was a diversion away from buying massive amounts of depreciating dollars. (At present $ 230 bn).

The great paradox: The US strongly criticizes China for having oil-dealings with rogue states. This time China wanted an M&A deal in a “stable” country.

China craves global integration but was rejected just for reasons of hypocrisy and paranoia. .

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Some Major Sino-European M&A and Some Major Sino-European M&A and Major Chinese Contracts in Europe Major Chinese Contracts in Europe

In November 2003, Thomson and Chinese firm TCL merged their TV and DVD manufacturing to create the world biggest TV maker.The Chinese group will own 67 % of the venture, to be called TCL-Thomson, with the remainder held by the French group. The JV will have factories in China, Vietnam, Germany, Thailand, Poland and Mexico.

Huawei is now the world's second-largest supplier, after Alcatel of advanced digital-subscriber lines, the primary conduit for the world's broadband connections. Last year, Huawei won contracts in France, Spain, Germany, Holland and Portugal.

Haier, China’s largest household-appliances manufacturer has factories in Slovenia and Italy.

After an on and off M&A and rescue process with the Shanghai Automobile Industry Corporation SAIC’s rival Nanjing Automotive Group has agreed to buy other parts of Rover and set up a new company with British entrepreneurs.

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Punishment of Foreign Companies by the US; Punishment of Foreign Companies by the US; Europe more willing to transfer Technology Europe more willing to transfer Technology

The United States penalized eight Chinese companies, including some of the country's biggest military contractors, for supplying missile technology to Iran. ( >Taiwan)

The arms transfers to Iran, a more practical problem, illustrate the widening European-American divide on strategic thinking about China, with Europe less inclined to impose restraints on China than the United States.

The Australian company BHP Biliton is licensed to use the American geological survey technology “Falcon” since 1999 to detect underground deposits of minerals from aluminum to zinc.

In April 2005, the Pentagon told BHP it will not be allowed to use the system in China.

The disclosure came as the US was seeking to prevent Europe from lifting the arms embargo against China.

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GalileoGalileo

The EU on July 28 signed contracts with a group of Chinese companies to develop a range of commercial applications for Europe's planned Galileo satellite navigation system.

The announcement is likely to ruffle feathers at the U.S. Defense Department, which controls the rival Global Positioning System, a system it is racing to upgrade.

Beijing has contributed $ 230 m to develop Galileo but has also put pressure on the EU to gain access to Galileo's sensitive military data and technologies.

After a difficult discussion with the US, the EU has declined that request.

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Drop of Chinese Students in Drop of Chinese Students in US Benefitting EuropeUS Benefitting Europe

EU officials also estimate that as many as 100,000 Chinese students were registered in European universities and technical colleges during the 2003-2004 academic year, with perhaps half in the United Kingdom alone.

This number considerably exceeds the approximately 60,000 Chinese students registered in the United States. Because strict US government visa restrictions are expected to cause an estimated drop of at least 100,000 foreign students on American campuses in 2004–2005, many of these, including Chinese, will go to Europe instead.

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Europe and China both refuse to Europe and China both refuse to play by “Sarbanes-Oxley” Rulesplay by “Sarbanes-Oxley” Rules

Last year, the EU invited China to participate in three way talks with the US to find alternatives for the Sarbanes Oxley Act. Foreign companies listed in the US would be submitted to the same stringent accounditing and auditing laws as all American companies.

EU top-officials said it was “simply unrealistic, impossible” to enforce the rules on overseas firms. No early agreement was reached and many European companies de-listed from the NYSE to avoid the very high cost of meeting Sarbanes Oxley requirements..

In 2005 China Construction Bank (CCB) and Bank of China would list in Hong Kong and New York. The two banks are expected to raise between $ 4 billion and $ 10 billion each in what should be two of the largest IPO’s in the world for this year.

However, afflicted by frequent fraud scandals, things did not play out according to plan. CCB made it known that it considered shunning New York and listing its shares only in Hong Kong, because of the high cost and strict requirements of US corporate governance rules, as stipulated in the tough Sarbanes-Oxley Act.

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The Textile War: The Textile War: EU CompromiseEU Compromise

The EU and China signed a deal on 5 September that will permit the release of nearly 80 million pieces of imported Chinese clothing that have been impounded at EU borders, thus ending an episode in what the British press has dubbed the "bra wars."

It thus effectively amends the terms of the 10 June agreement that limited ten types of Chinese textiles exports to the EU to annual increases of no more than 8 to 12.5 percent over the next three years.

China agreed to let half of this increase be counted against the import quotas for 2006, while the EU agreed to allow the rest to be imported over and above the previously agreed quantities.

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The Textile War: The Textile War: US Unilateral Reimposition US Unilateral Reimposition of Quotasof Quotas A third round of negotiations collapsed on October 1. "We will be

meeting with the Chinese again next month. "But the US will have no hesitation in walking away from a bad deal“, chief negotiator David Spooner said.

On September 1, after a previous round failed, the US Committee for the Implementation of Textile Agreements (CITA), a government body, imposed limits on imports of bras and synthetic filament fabrics, using the textile-specific safeguard clause from China's WTO accession agreement that allows WTO Members to restrict Chinese textile exports to an increase of 7.5 percent per year.

China wants an annual growth rate of 20 % The demand for new quotas is strong among textile

organizations and the authorities consider them favorably.

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EU and US in full agreement EU and US in full agreement that China does not deserve that China does not deserve Market Economy Status NowMarket Economy Status Now

The EU has been a stringent enforcer of China’s obligations and has been particularly tough-minded against Beijing’s demands that China be granted market-economy status (MES), which would effectively eliminate antidumping tariffs.

In 2004 an EU internal study concluded that China still fell far short on four of five criteria necessary to achieve MES status. Over the past year, Beijing has exerted considerable pressure on Brussels to grant MES and relax its antidumping penalties, but thus far the EU has not succumbed to this pressure.

For its part, the U.S. Department of Commerce is also bringing an increasing number of antidumping cases against Chinese firms. In both cases, this trend reflects not only unfair Chinese trade practices, but also the ballooning trade deficits that the EU and United States have with China.

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Triangular ManoeuvresTriangular Manoeuvres China and Europe have had a series of disputes over trade and

MES status as well as disagreements over human rights. Europe has concerns about China’s proliferation practices, as well as the arms embargo.

More recently, China’s Europe specialists have begun to criticize the motives underlying EU programs to promote civil society in China as an ideological ruse to “Westernize and divide China” (Xi-hua, fen-hua).

The EU and the United States sometimes side with each other, China and the EU sometimes find themselves in agreement, the United States and China sometimes work well together, and sometimes the interests and policies of all three intersect, while each side simultaneously has disputes with the other two.

What has not occurred, to date, is a situation where U.S. and Chinese perspectives converge against European interests.

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Peter Mandelson on Peter Mandelson on Globalization, Free Trade Globalization, Free Trade and Protectionismand Protectionism Europe has to develop a much more sophisticated response to

the challenge of globalisation. Let me suggest four principles for action:

– First, Europe has to attract talent from all over the world.– Second, we should launch a drive to promote inward investment and

industrial collaboration.– Third, Europe should pursue a policy of openness to the world.– Fourth, we need more explicit policies in Europe to address the problems of

the ‘losers’ from globalisation and tackle the new inequalities that globalisation brings.

Mandelson is already under pressure to take anti-dumping measures against Chinese shoes, whose imports are devastating the Italian footwear sector. 

“Yesterday textiles, today footwear, tomorrow what ? Consumer electronics ? Cars ? Where will it go and when will it end ? We are at the beginning of the China story, not the end.”