reilly chinas economic statecraft web

8/13/2019 Reilly Chinas Economic Statecraft Web

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N O V E M B E R 2 0 1 3

Chinas economic

statecraft: turning

wealth into power

E x e c u t i v e s u m m a r y

Never in world history has one government had so much control overso much wealth. It is no surprise, therefore, that Beijing is deploying itsvast economic wealth to advance foreign policy goals. China is usingeconomic statecraft more frequently, more assertively, and in morediverse fashion than ever before. Yet fears of Chinas economiccoercion should not be overdrawn. Diverging interests across the broadarray of state and commercial actors engaged in Chinas economicstatecraft impedes effective policy implementation. A review of caseswhere China has used economic sticks or carrots shows a mixed recordof success. Indeed, in many respects Chinas use of economic statecrafthas been counterproductive. These constraints, along with Chinasdomestic challenges and Australias considerable economic advantages,limit Australias vulnerability to potential economic coercion from itslargest trading partner.

JAMES REILLYSenior Lecturer,University of [email protected]

LOWY INSTITUTE FORINTERNATIONAL POLICY31 Bligh Street

Sydney NSW 2000Tel: +61 2 8238 9000Fax: +61 2 8238 9005www.lowyinstitute.org

A N A L Y S I S


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The Lowy Institute for International Policy is an independent policy think tank. Its mandateranges across all the dimensions of international policy debate in Australia economic, politicaland strategic and it is not limited to a particular geographic region. Its two core tasks are to:

produce distinctive research and fresh policy options for Australias internationalpolicy and to contribute to the wider international debate.

promote discussion of Australias role in the world by providing an accessible andhigh-quality forum for discussion of Australian international relations throughdebates, seminars, lectures, dialogues and conferences.

Lowy Institute Analyses are short papers analysing recent international trends and events andtheir policy implications.

The views expressed in this paper are entirely the authors own and not those of the LowyInstitute for International Policy.


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Chinas economic statecraft: turning wealth into power

In December 2009, Cambodia agreed to deporttwenty ethnic Uighurs back to China to beprosecuted in connection with the July 2009violent anti-government protests in Xinjiangprovince. Several weeks later, Chinas Vice-President Xi Jinping arrived in Cambodiabearing gifts: US$1.2 billion in grants andloans. The US State Department responded toCambodias decision to deport the Uighurs by

cancelling a shipment of 200 surplus militarytrucks to Cambodia. Three weeks later, Chinadonated 257 trucks. 1 By 2012, Chinas pledgedloans and grants to Cambodia reached US$2.7billion. This benevolence seemed to pay off in

July 2012, when Cambodia used its power aschair of the ASEAN Summit to block a jointstatement criticising Chinas approach toterritorial disputes in the South China Sea. 2

Such strategic use of Chinas financial resourcescauses anxiety in Asia and around the world,and with good reason. Never in world historyhas one government had so much control overso much wealth. Chinas leaders govern acountry that has the worlds largest capitalsurplus and its second largest economy, ahighly coveted domestic market, and a currencywith growing regional appeal. The temptationto deploy Chinas economic might for strategicbenefit has proven irresistible. China today is

using economic statecraft more frequently,more assertively, and in more diverse fashionthan ever before.

Economic statecraft is the use of economicresources by political leaders to exert influencein pursuit of foreign policy objectives. Thereare three main strategies: providing capitalthrough foreign aid or direct investment;expanding trade via preferential tradeagreements or state procurements; and altering

monetary policies such as purchasing foreignbonds or intervening in currency markets.These tools can be deployed either as incentivesor as punitive measures. The degree of politicalinfluence that China is able to wield withparticular countries will vary. Above all, sizematters. Given Chinas economic heft, a minorshift in Chinas trade, aid, or investment canhave a massive effect upon a smaller economy.

The aim of this Analysis is to examine thebroad range of actors and techniques used inChinas economic statecraft and to understandhow effective it is in achieving Chinas foreignpolicy goals. 3 Research for this Analysis drawsupon extensive interviews and field research inBeijing, and in Liaoning, Jilin, Xinjiang, andYunnan provinces, as well as from Chinesegovernment documents, media reports, andacademic studies.

The first part of the paper argues that Chinassocialist legacy, augmented by its state-leddevelopment model, offers Chinas leaderssignificant ability to deploy the statesenormous economic assets to advance theirdiplomatic agenda. The second part examinesthe way that Beijing uses both economic carrotsand sticks for strategic purposes. The third partconsiders the limits of Chinas economic

statecraft. These limitations are explored in thepapers final part, which addresses the potentialimpact of Chinas economic statecraft onAustralia.

New thinking on new wealth

Chinas use of economic means to advance itsstrategic and diplomatic objectives is hardlyunique countries have always sought todeploy economic tools for strategic advantage.


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Nor is Chinas own use of economic pressurenew. Since the founding of the PeoplesRepublic in 1949, Chinas leaders haveprovided aid or refused trade in support ofbroader strategic and ideological objectives. Butin recent years, as Chinas economic might hasrisen, its ability and the temptation to use thatpower has grown. Chinas strategists, guided bya pragmatic pursuit of greater influence, have

begun to reconsider how to best deploy theirnational riches.

Chinas economic advantage has not yet beentranslated into strategic advantage, complainsTsinghua University Professor Zhao Kejin. 4 Experts have suggested a variety of tools thatBeijing could deploy: limiting investments,imposing trade restrictions, freezing financialassets, punishing or rewarding foreigncorporation, and shifting foreign currencyholdings. 5 As a major study from the ChinaInstitute for Contemporary InternationalRelations, an influential think tank associatedwith the Ministry of State Security, concludes:given the fact that our nation has increasingeconomic power, we should prudently useeconomic sanctions against those countries thatundermine world peace and threaten ourcountrys national interests. 6

Chinas national wealth is imposing. Itsagricultural and industrial output is the worldslargest. It is the worlds second-largest exporter(US$2 trillion) and its third-largest importer(US$1.7 trillion). 7 This economic heft confersconsiderable trading leverage. China is thelargest trading partner for over a hundredcountries, including Australia, Japan, SouthKorea, Vietnam, Malaysia, Indonesia andIndia.

Chinas overall trade surplus has enabled it torun up the worlds largest current accountsurplus (US$213.8 billion) and amass foreignexchange reserves of US$3.3 trillion. Chinaholds one-fifth of all foreign-owned USTreasury securities. 8 Chinas overseas foreigndirect investment (FDI) stock of US$502 billionis less significant: only the 14th largest. In2012, Chinas FDI outflows of US$62.4 billion

lagged behind the United Kingdom andGermany, and were only half of Japansoutward FDI although Chinas investmentshave risen sharply since 2005. 9 More significantthan aggregate wealth, however, is thepervasive control that the government exercisesover these resources.

Chinas political industrial complex

Chinas socialist legacy and its state-leddevelopment model have left Chinas leaderswith enormous control over its economy evenif that control has real limits. Five governmentagencies sit at the apex of the states economicpower. The Ministry of Commerce(MOFCOM) oversees companies and policieson foreign trade and investment, and directlyadministers foreign aid. The NationalDevelopment and Reform Commission(NDRC) sets industrial policy and approves

major development projects. The State-ownedAssets Supervision and AdministrationCommission (SASAC) is the owner of Chinaslarge state-owned enterprises (SOEs), taskedwith increasing the value of these state assets.The financial sector is dominated by theMinistry of Finance (MOF), which manages thenational budget, sets fiscal policy, issueseconomic regulations, and shapesmacroeconomic policies. Chinas central bank,the Peoples Bank of China (PBoC), manages


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currency flows, sets banking policies and, alongwith the China Banking RegulatoryCommission (CBRC), oversees all banks.

Capital for Chinas economic statecraft comesprimarily from the banking sector. Two policybanks tasked with implementing governmentpolicies, play key roles. China DevelopmentBank (CDB) helps finance infrastructure and

energy projects in China and abroad. Export-Import Bank of China (Eximbank) financestrade deals and provides subsidised loans forChinas aid program. Chinas commercialbanks are also owned by the state, though theyare expected to be profitable. The four largestare the Industrial and Commercial Bank ofChina (ICBC), Bank of China (BOC), ChinaConstruction Bank (CCB), and the AgriculturalBank of China (ABC). The China InvestmentCorporation (CIC) is Chinas sovereign wealthfund. Short-term foreign reserves are held bythe State Administration of Foreign Exchange(SAFE).10

These are massive institutions. ICBC is theworlds largest bank; three other Chinese banksare in the top ten. 11 The nations leadingforeign-currency lender CDB has total assetsexceeding US$900 billion more than theWorld Bank and Asian Development Bank

combined.12

Over the past decade, Eximbanksloans to sub-Saharan Africa vastly exceededfunds lent by the World Bank. 13 SAFE is rankedas the worlds third largest sovereign wealthfund, with US$568 billion; CIC is fifth, withUS$482 billion in assets. 14 The state dominatesthe entire sector: 98 per cent of Chinasbanking assets are state-owned. 15

Over the past decade, government control ofthe economy has strengthened, as an earlier

trend toward the privatisation of state assetswas halted. At the core are Chinas state-ownedenterprises (SOEs), which receive three-quartersof all state bank loans. 16 They generate 35 percent of all business activity and 43 per cent ofall profits in China. 17 Of the 85 Chinesecompanies in the 2013 Fortune Global 500 list,90 per cent are SOEs. Three made Fortunestop ten: Sinopec (4th), China National

Petroleum Corporation (CNPC) (5th) and StateGrid Corporation of China (7th). 18 SOEsoccupy all ten top slots on Fortunes China 500list. 19 Chinas 20 largest outward investors,generating 92 per cent of outboundinvestments, are all state-owned. 20

Diplomacy by other means

In recent years the temptation to deploy theseformidable economic assets to pursue Chinasforeign policy interests has proven irresistible.It would be wrong to assume that Chinaseconomic statecraft is guided by a coherentgrand strategy however. Instead, it is bestunderstood as the selective application ofeconomic incentives and punishments designedto augment Beijings diplomacy. In some cases,China exerts influence through reciprocity, inwhich desired behaviour is rewarded whileundesired behaviour is punished. In other

instances, Beijing provides benefitsunconditionally, in the hope that sustainedeconomic engagement will eventually produce apolitical transformation and desirable changesin target behavior. 21 Such influence is moreindirect, as China hopes that the benefits oftrade and investment empower a commercialfifth column within the target country thaturges accommodation with Chinaspreferences. 22


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As Chinas foreign policy agenda has becomemore crowded and complex, its leaders haveturned to a range of economic resources toencourage other states to act in ways consistentwith Beijings policy preferences. While Beijinghas not been shy about wielding economiccoercion to defend its core national interests,Chinas leaders generally prefer carrots tosticks. Foreign aid, state purchases, generous

trade agreements, and cross-borderinfrastructure projects have emerged as usefularrows in Beijings diplomatic quiver.

Offering carrots

Foreign aid is a key resource for Chinaseconomic statecraft. By its own account, Chinahad distributed aid to 161 countries by the endof 2009, including 123 developing countries:30 in Asia, 51 in Africa, 18 in Latin Americaand the Caribbean, 12 in Oceania and 12 inEastern Europe. Like all donors, Chinas aid isused to help bolster important diplomaticrelationships, particularly in Africa andSoutheast Asia. Approximately 80 per cent ofall Chinas aid goes to Asia and Africa. 23

Chinas aid projects generally originate fromrecipient country requests and areoverwhelmingly oriented toward infrastructure

projects, generally undertaken by Chinas firms.The recipient country obtains a new road orbuilding, but rarely any cash transfers. Seekingto address recipients domestic politicalconcerns, Beijing often finds itself supportingprestige projects such as the Don Chan Palace,a five-star hotel in Vientiane, or the LaosNational Stadium, built for the 2009 SoutheastAsian Games. 24

China also relies upon selective purchasingdiplomacy, in which Chinas state-ownedenterprises make or forgo purchases ofprominent commercial goods to either rewardor punish foreign states for their diplomaticpolicy. 25 Such purchases help temper foreigndisquiet over Chinas rising power. On his May2013 visit to Germany, Premier Li Keqiangfaced mounting German criticism over Chinas

subsidies of solar panels. In response, Li openedhis cheque book, overseeing major commercialdeals and dangling the possibility of Germanfirms obtaining contracts as a part of Chinastransition to a green economy. 26

Purchasing diplomacy has also buttressedBeijings struggle to discourage foreign leadersfrom meeting with the Dalai Lama. In 2009,after French officials announced that PresidentNicolas Sarkozy (who at the time also held therotating EU presidency) would meet the DalaiLama, China postponed the 11th annual EUChina summit, to be held in Paris, and froze anorder for 150 Airbus planes. Two Chinesetrade delegations quickly crossed France offtheir travel agendas: the first delegation alonesigned US$15 billion worth of trade deals inother European countries. Before his January2009 European tour, Premier Wen Jiabaonoted: I looked at a map of Europe on the

plane. My trip goes around France We allknow why. 27 In response, Paris issued astatement recognising Tibet as an integral partof Chinas territory. A Chinese trade delegationsoon landed in Paris. As a China Daily articlechortled, France goes back on Chinasshopping list. 28


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In delivering economic benefits, Chinese leaderspay careful attention to timing. Sending coal inthe midst of a snowstorm, as the Chinesesaying goes, maximises political benefits. Theglobal financial crisis was a major snowstorm an opportunity for Beijing to purchase politicalcapital cheaply. In April 2009, Premier Wen

Jiabao announced a US$10 billion investmentfund for regional infrastructure in Southeast

Asia, along with a US$15 billion line of creditfor poorer ASEAN states and US$40 million inspecial aid for Cambodia, Laos andMyanmar. 29 In Athens the following October,Wen promised to purchase Greek governmentbonds, encourage investment and tourism, andestablish a US$5 billion fund to help Greekshipping companies buy Chinese ships. Inexchange, Wen explained, we hope the EUrecognizes as soon as possible Chinas fullmarket-economy status, and will relaxrestriction on high-technology exports to Chinaand oppose trade protectionism. 30

For wealthier nations, Chinas leaders relyupon the lure of their domestic market and thepotential of Chinese investment to swayreluctant leaders. Canadian prime ministerStephen Harper, for instance, skipped the 2008Beijing Olympics while promising Canadianvoters that he would never sell out Canadian

values for the almighty dollar. Yet when hefinally visited Beijing in 2009, after a four-yearhiatus, Harper signed a joint statementacknowledging that differing histories andnational conditions can create some distinctpoints of view on issues such as humanrights. 31 In exchange, Chinas leaders promisedto send trade and investment delegations, fundresearch centres, and promote Chinese tourismto Canada. As Wenren Jiang explains, Harpersvisit provides a clear example of how political

engagement with China at the highest level candeliver tangible economic benefits. 32

Beijings enmeshment strategy

China has promoted greater trade andinvestment with its 14 land neighbours. Thisstrategy offers Beijing a classic win-winopportunity: drawing nearby countries into

Chinas economic orbit while bolstering itsdiplomatic leverage and creating commercialopportunities for Chinese firms. Chinas pushfor regional infrastructure is at the heart of thiseffort. In recent years, Beijing has funded athickening network of cross-border railways,roads, and oil and gas pipelines acrossmainland Asia. 33 These projects enhanceChinas access to strategic natural resources,while meeting pressing infrastructurerequirements among Chinas poorerneighbours. China has also ramped up itssupport for new regional institutions to fundcross-border projects, including President Xi

Jinpings recent call to establish an AsianInfrastructure Bank. 34

To further facilitate economic integration andencourage domestic constituencies to supportcloser relations with China, Beijing has alsooffered preferential trade deals to key regional

partners. China has already signed 11 free tradeagreements, and is currently negotiating fourmore, covering a total of 31 economies.


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Table 1: Chinas Free Trade Agreements 35

While driving a hard bargain in trade talks withlarge, wealthy nations, Beijing has beensurprisingly magnanimous toward smaller but

strategically important economic partners. Toassuage concerns over political integration,Beijing offered both Hong Kong and Macaogenerous Closer Economic PartnershipArrangements in 2003. China also included agenerous Early Harvest Program in the 2002China-ASEAN Free Trade Agreement(CAFTA), opening Chinas markets to ASEANagricultural imports. Instead of exacting thebest deal possible for China, Beijing structured

CAFTA to reassure Chinas Southeast Asianneighbours and give them a stake in Chinaseconomic success, striving to present itself as abenevolent regional hegemonic power. 37 CAFTA also bolstered Beijings pursuit ofWTO recognition as a market economy astatus ASEAN accorded China in September2004.

As a subsequent section discusses in detail,there are limits to which Chinas governmentcan direct even state-owned companies toengage in activities related to economicstatecraft. The government actually has limitedcontrol over our companies, explains a formerChinese diplomat. Even if Chinese leaderspromise to increase imports from a givencountry, they have little capacity to deliverthis. 38 One way around this is for state-ownedbanks to establish investment funds designedspecifically to encourage Chinese firms to investin certain countries or regions for strategic ordiplomatic purposes. The first such fund wasthe China-Africa Development Fund, created in2007 with US$1 billion in funding from theChina Development Bank. More recently, theChina Overseas Investment Federation, anominally non-state entity, established aUS$470 million Fund for Investment intoNorth Korea in 2012. 39 The new fund reflects

Beijings efforts to encourage greater corporateinvestment and trade with North Korea, apolicy described as the government guides butcompanies lead, [with] market-basedoperations and mutual benefit. 40

Wielding the stick

It is no great surprise that Chinese leadersprefer using economic carrots rather than sticksas a means of obtaining diplomatic benefits. In

Concluded agreements Country/region YearASEAN 2002Hong Kong 36 2003Macao 2003Chile 2005Pakistan 2006

New Zealand 2008Singapore 2008Peru 2009Costa Rica 2010Iceland 2013Switzerland 2013Under negotiation Country/region Negotiations beganGulf CooperationCouncil

2004

Australia 2005Norway 2007China-Japan-SouthKorea

2013

Joint Study Group EstablishedIndia 2003South Korea 2004


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their view, incentives offer mutual economicbenefits a win-win outcome. Spreadingeconomic goodwill also eases diplomaticrelations, tempers public anxiety over Chinasrise, and builds closer economic and politicalties. Yet Beijing also remains willing to deploypunitive economic measures in defence of corenational interests.

For Chinas leaders, sanctions offer a low-cost,low-risk way to signal dissatisfaction, increasethe costs to states that take undesired actions,and satisfy domestic demands to dosomething. Beijing often uses the spectre ofsanctions as diplomatic language a costlysignal of frustration. They also serve as adeterrent warning that if the action is notreversed, China will be forced to take evenmore stringent action, and that other states riskfacing similar economic costs for crossingBeijings red lines.

This signalling strategy was on display in January 2010, following the US announcementof a US$6.4 billion arms sale to Taiwan. Vice-Foreign Minister He Yafei threatenedAmbassador Jon Huntsman that China wouldimpose sanctions against [US] companies thatwill engage in arms deliveries to Taiwan. 41 While no overt sanctions were implemented,

China has already successfully deterred othercountries from selling arms to Taiwan. The lastmajor European sale to Taiwan was Frances1992 sale of Mirage fighter jets. It promptedBeijing to close the French consulate inGuangzhou and cost French companies theopportunity to help build the Guangzhousubway. 42

Unlike US sanctions, which are formalisedthrough domestic law and/or presidential

decisions, China rarely openly declares itseconomic sanctions. Instead, Beijing prefers touse vague threats, variation in leadership visits,and other informal or indirect measures,enhancing Beijings flexibility while minimisingdiplomatic fallout. In March 2012, forinstance, Xinjiang provinces Party chairmanNur Bekri decried countless links betweenlocal terrorists and Pakistan. A few weeks later,

the ICBC withdrew promised financing for agas pipeline from Iran to Pakistan signallingBeijings displeasure. 43

China has also threatened economic sanctionsto counter criticism of its human rights policy,such as the 2010 awarding of the Nobel PeacePrize to jailed dissident Liu Xiaobo. After theaward was announced, China promptlycancelled a ministerial trade delegation toNorway. 44 Over the next two years, the Chineseforeign ministry refused to receive Norwaysambassador to Beijing, while the bilateralhuman rights dialogue and free tradenegotiations were postponed indefinitely. 45 Norwegian salmon exports to China alsodropped by half in early 2011, though overallbilateral trade between China and Norwayexperienced no Nobel effect according toStatistics Norway. Instead, bilateral trade rosesharply over 2011. 46

Even the Chinese public has gotten into thesanctions game. Hollywood film studios,French supermarkets, Italian carmanufacturers, and British universities have allapologised for hurting the feelings of Chinesepeople, in the hope of avoiding consumerboycotts. 47 The most recent example emergedduring the 2012 anti-Japan protests in responseto the Japanese governments purchase andnationalisation of the contested


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Senkaku/Diaoyu islands. As emotions swelled,Chinese consumers declined to buy Japanese-brand electronics and cars, and begancancelling visits to Japan. As one blogger put it:the boycott of Japanese goods begins withme.48

As the boycott grew stronger, commerceministry spokesman Shen Danyang offered

implicit support for such rational patrioticactivities. 49 Customs authorities begantightening their inspections of seaborne importsfrom Japan and delayed their approvals of

Japanese working visas. 50 Japanese firms wereasked to withdraw from an international tradefair in Chengdu and tourists were discouragedfrom visiting Japan. 51 Most notably, Chinesebanks and financial officials withdrew from theannual World Bank-IMF meetings held inTokyo from 12-14 October. 52 Citing declines in

Japanese car sales and investments in China, J.P. Morgan downgraded its projections for Japans economy for the final quarter of2012. 53 Overall trade figures, however, soonpicked up. In 2012, while global foreign directinvestment in China fell by 3.7 per cent,

Japanese investment actually rose by 6 percent. 54

When does it work?

While a comprehensive assessment of theeffectiveness of Chinas economic statecraft isbeyond the scope of this paper, the precedingdiscussion does suggest a few preliminaryconclusions. The first is that size is the mostimportant factor. The degree of politicalinfluence generally increases with theasymmetry of the economic relationship. GivenChinas economic heft, a minor shift in Chinastrade, aid or investment can have a massive

effect upon a smaller, more dependenteconomy. Neighbours such as Laos orCambodia are thus more likely to accede toBeijings pressure than larger economies such as

Japan or South Korea.

Much also depends on the issue at stake,namely its relative significance for the countryfacing Chinese pressure. The Dalai Lama is a

case in point. One study finds that from 2002through 2008, a reception by a countryspolitical leader of the Dalai Lama resulted in anaverage 12.5 per cent drop in exports to Chinafor the following two years. The mostsignificant and consistent effect is in exports ofmachinery and transport equipment (i.e.airplanes), goods commonly sold during statevisits and trade missions. 55 For many countries,maintaining close economic ties with China willtrump their interest in receiving the DalaiLama, although others remain unwilling tosubmit to such coercive measures. Thedifficulty of this dilemma is evident in themixed record of how countries respond to visitsby the Dalai Lama.

Concern with Beijings response has certainlyconstrained some Australian policymakers.Prime Minister John Howard met the DalaiLama in 1996, refused to do so in 2002, and

then met him again in 2007. Since then, theDalai Lama has not been received by a standingAustralian prime minister. Following his June2011 visit, during which Prime Minister JuliaGillard and Foreign Minister Kevin Rudd wereboth (rather conveniently) abroad, then GreensParty leader Senator Bob Brown thundered: Itshould be happening. But here we have anotherprime minister kowtowing to the communistbosses in Beijing rather than standing up forthis nation. 56


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European states have proven more resilient,accounting for roughly half of all Dalai Lamareceptions by government members. The UnitedStates is the most hospitable: the Dalai Lamahas met with the last four US presidents,numerous congressional leaders, and has spentmore days in the United States than any othercountry (aside from India). Yet even Americahas been cautious. In September 1995, for

example, President Bill Clinton arranged for acabinet member rather than himself to receivethe Dalai Lama, but then he casually droppedin for a quick chat. The New York Timesruefully admitted that a more official receptionwould [have] cost us trade with the Chinese. 57 After UK prime minister David Cameron metwith the Dalai Lama in May 2012, Beijingthrew diplomatic relations into a deep freezefor 14 months before agreeing to meet withCameron again. 58

Finally, carrots have generally been moreeffective than sticks. In the case of Taiwan, forinstance, Beijing used the lure of its domesticmarket and manufacturing capacity to attractTaiwans investors. Beijings blandishmentswere finally reciprocated after Kuomintang(KMT) Party leader Ma Ying-jeou won theMarch 2008 presidential election. In 2010, Masigned the Economic Cooperation Framework

Agreement (ECFA) the first FTA betweenWTO members with a territorial conflict. LikeCAFTA, ECFA strongly favours agriculturalinterests in Taiwans green South atraditional stronghold of anti-mainlandsentiment. By 2020, Taiwan expects to sendsome 62 per cent of its exports to the mainland,bolstering its substantial trade surplus withChina. An estimated two million Taiwanesebusinesspeople now live in China; a millionChinese tourists visit Taiwan annually. 59 For

Beijing, its reward came when Ma was re-elected on 14 January 2012 aided byTaiwans business communitys support fordeepening cross-strait economic ties. 60 WhileMas plummeting support augurs newchallenges for Beijings strategy, trends in cross-strait ties have shifted dramatically in Chinasfavour.

In contrast, economic coercion has provencounterproductive in Chinas maritimedisputes. In response to the consumer boycottsand economic pressure, Japan has refused toback down over the Senkaku/Diaoyu islands.Instead, Tokyo has strengthened itscooperation with other Asian neighbours,signed a fisheries accord with Taiwan, andsecured statements of support from the UnitedStates. Similarly, Chinas decision to restrict itsimports of bananas from the Philippines duringa 2012 territorial dispute yielded a defiantresponse, spurring nationalist sentiments inManila and closer collaboration with theUnited States.

Beijings blunt instrument

Despite the growing number of examples ofChina using both economic sticks and carrotsin pursuit of statecraft, there are reasons why

these will remain blunt, often ineffective, andsometimes counterproductive weapons.Notwithstanding the high level of state controlover Chinas economy, it is not always easy toget its companies to do the governmentsbidding. Even when officials do manage tocoordinate policy implementation, the costs toChinas domestic economy render coercion anexpensive option. Furthermore, growingeconomic dependence upon China has


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exacerbated anxieties around Asia, spawningpopular backlashes and strategic balancing.

Beijings ability to use Chinese companies inpursuit of foreign policy interests faces severalconstraints. Most importantly, it requirescoordination across a vast and complex arrayof state-owned corporations and governmentbureaucracies with unequal bureaucratic

ranking. It is often difficult, if not impossible,for Chinese diplomats to order powerful state-owned enterprises to take steps that maycompromise their commercial interests. Even ifnational leaders determine that a certain policyis essential to Chinas national interests,implementing such measures across Chinas far-flung economic juggernaut in a timely andeffective fashion is extremely difficult.

In his 2012 work report to the NationalPeoples Congress, Premier Wen Jiabao insistedthat the government would guide Chineseenterprises under various forms of ownership inmaking overseas investments in an orderlymanner. 61 However, by promoting overseasinvestments for political purposes, Chinasgovernment is creating a classic moral hazard.Chinese corporations may feel free to act in afiscally irresponsible manner because they feelthey are acting on direction from the state and

can depend upon state-controlled banks forfinancial support if the enterprise they areengaged in is not profitable. For example, a2008 PBoC report estimated that companies inone border city in Northeast China alone havelost some US$20 million investing in NorthKorea. 62

Domestic actors may even hijack the policyprocess, manipulating strategic concerns toadvance their own interests. The oil and gas

pipelines built through Myanmar are a goodexample. Yunnan province officials and expertscollaborated with national oil companies(NOCs) to feed fears of a Malacca Dilemma the concern that China has become toodependent on energy flows through thevulnerable Malacca Straits. Yunnan officialsand the NOCs promoted the pipelines as asolution, despite their US$2.5 billion price tag

and vulnerability to domestic instability. AsChen Shaofeng observed, in this case thepreferences of the Chinese government and theNOCs do not coincide. 63 Private firms are evenmore aggressive than SOEs in pursuingoverseas markets. They have few obligations toChinese diplomats or national bureaucracies,relying instead upon a carefully cultivated localbase of support. Successful local privateentrepreneurs in China must cut corners tosucceed. Commonplace acts such as bribingofficials, falsifying contracts, and evading lawsare unlikely to decline as they move far fromhome. Instead of serving as reliable agents forBeijings economic statecraft, ambitiousChinese firms exacerbate outsiders anxietyover Chinas rise.

Generating backlashes and balancing

Beijing has struggled for decades to cultivate a

reputation as a responsible member of theinternational economic system and has soughtto ease fears of a China threat, particularlyamong its Asian neighbours. Worried aboutpublic opinion risk undermining these efforts,MOFCOM has urged Chinese firms to adopt amore low-key approach when investingabroad. 64 Indeed, survey data shows that, fairor not, Asian citizens tend to blame Chinawhen their own economies turn downward. 65 But this is not limited to Asia. In Zambia, for


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instance, Michael Sata rode a populist wave ofanti-China sentiments to his 2011 election aspresident even though China has investedmore than US$300 million in Zambia andemployed more than 10,000 Zambians. 66 Suchpopular anxiety encourages changes in policy,such as Mongolias recently tightenedrestrictions on foreign investment. 67

Chinas aid, investment, and trade benefits aredesigned to signal Beijings benevolent intentand highlight the benefits of accommodation.Yet Chinas generosity also exacerbates fears ofdependence, particularly among its smallerAsian neighbours. As US Secretary of StateHillary Clinton told a Cambodian audience, Ithink its smart for Cambodia to be friendswith many countries. Look for balance. Youdont want to become too dependent on anyone country. 68 A number of Southeast Asianstates, including Beijings erstwhile ally,Myanmar, have taken Clinton up on the offer,welcoming the USs pivot back to Asia, in partas a hedge against rising Chinese influence. 69

Costs for China

Economic coercion is also costly for China. Assome Chinese experts pointed out during the2012 consumer boycott, refusing to buy

Japanese cars also hurts Chinese workers, andso is irrational and self-destructive. 70 Indeed,trade sanctions erode investor confidence andhurt domestic manufacturers. Chinas massivetrade surplus relies heavily on importingintermediate materials and exporting finishedproducts. Selective trading bans disrupt thesecomplex production chains, chasing investorsto alternative manufacturing locations such asVietnam. Politically, Chinas leaders can ill-afford to undermine their export-

manufacturing sector, particularly amidstglobal economic uncertainty. 71

Beijing can limit access to its lucrative domesticmarket yet this approach also has its limits.The purchasing power of Chinas consumersremains constrained by low average incomes,negative real interest rates fixed by state-ownedbanks, and the need to save for social welfare

expenses. Chinas massive state-driveninvestments in response to the global financialcrisis have further delayed Chinas long-awaited transition to a consumer-driveneconomy. 72 For these and other reasons Chinacontinues to depend upon market access,technological transfer, and capital provisionfrom many of the wealthy nations that it mayseek to sanction. Even Chinas massive holdingsof US government debt offer scant politicalleverage, given Beijings reliance uponAmericas capital markets and currency. AsDaniel Drezner quips, when the United Statesowes China tens of billions, that is Americasproblem. When it owes trillions, that is Chinasproblem. 73

Even offering preferential trading terms entailseconomic costs. The generous early harveststhat Beijing proffered to ASEAN causedconsiderable resentment at home resolved

only by Beijings additional financial andpolitical support to Yunnan and Guangxiprovinces. 74 As China transitions into a highercost economy, protectionist pressures willgrow, increasing the costs of such sidepayments.


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Free trade with China: a dangerous deal?

Australia provides an excellent example of thelimits that China faces in using economicmeans in pursuit of strategic objectives. Likemany of their Asian neighbours, Australians arebecoming more worried about Chinaseconomic influence.

The 2013 Lowy Institute Poll found that 57 percent of Australians believe that the Australiangovernment is allowing too much investmentfrom China, despite the fact that Chineseinvestment constitutes less than 3 per cent oftotal foreign direct investment in Australia. 75 Alongside such concerns about Chineseinvestment are growing worries about China asa military threat. A significant minority (41 percent) see China as a likely military threat withinthe next two decades. While three in fourAustralians believe China is the most importanteconomy to Australia, sentiments towardsChina have cooled over the past year. 76 As theAbbott government embarks upon a new roundof negotiations with China over a free tradeagreement, Australians distrust of China mayconstrain the governments ability to reach adeal.

Chinas economic statecraft poses two potential

challenges for Australia. First, as Australiaslargest trading partner, China could holdAustralian exports hostage to political demandsover Australias military cooperation with theUnited States or engagement with Taiwan. 77

In fact, Australia enjoys considerable economicleverage over China. As then prime ministerKevin Rudd reminded Parliament in 2011: Inquality, price and proximity, the iron oreAustralia provides to China is without peer,

and not easily replaceable elsewhere on theworld market. Australia is Chinas top sourcefor mineral ores and coal, its second-largestsource of liquid natural gas, and sixth largestsource of fuels overall. 78 Australia, along withBrazil, dominates the global iron ore exportmarket. Even when Australia-China relationsfell to a generational low in 2009, Chinarestrained from using the economic lever, and

Australian exports to China continued toaccelerate. 79 Now that Beijing is struggling toavoid the middle income trap by transitioninginto a demand-driven, high-value economy,blocking its own access to key strategic inputsis even more unlikely, particularly amidlingering global uncertainty.

Second, China might manipulate itsinvestments in Australia for strategic purposes.Yet even here Australias exposure is limited.While Australia is the single-largest recipient ofChinas foreign direct investment, China is onlythe ninth largest source of accumulated FDI forAustralia, holding only 3 per cent of all directinvestment stock in Australia. In 2012, 90 percent of Chinese investment in Australia wentinto mining or gas projects; only 3 per centwent to agriculture. 80 Chinese firms invest inAustralia to mitigate their vulnerability to highprices while securing stable supply or raw

materials to serve Chinas burgeoningdemand. 81

Moreover, the Australian government andauthorities have shown a willingness to act incases where Chinese investments raise concernsover national security. For instance, the ForeignInvestment Review Board blocked ChinaMinmetals Corporations initial bid for OZMinerals due to concerns that one mine was inclose proximity to an Australia defence facility.


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China Minmetals revised its proposal toexclude this mine, enabling the overall bid togo through successfully in 2009. 82 Both Laborand Coalition governments have rejected bidsby the Chinese private firm Huawei to invest inAustralias national broadband network due tosecurity concerns. 83

Another risk that is sometimes raised is that

Chinese owners of mining stakes in Australiawill export products back to China at below-market rates for political purposes. Yet givendomestic pressure on Chinese companyexecutives to generate profits from their FDIprojects, aided by scrutiny by the Australiangovernment, shareholders, and media, suchtactics are extremely unlikely. The growingprevalence of Chinese investors pursuing off-take agreements, in which the investors take ashare of the production output whilemaintaining a non-majority share in thecompany, limits Chinas influence overcorporate decision-making. Growing numbersof private Chinese investors in Australia shouldhelp ease concerns over governmentmanipulation. 84

As recent history has shown, expanding tradeand investment with China is good forAustralian prosperity. The Australian

government will need to exercise due diligencein assessing investment arrangements, andshould encourage a diversity of export markets,as well as expanding Australias service sectorand agricultural exports to China. However,fears that Chinas government will manipulateits trade and investment to undermineAustralian autonomy or security areoverblown.

Both sides need to do a better job of explainingthis reality to the Australian public. Chinesediplomats need to more fully explain what astate-owned enterprise is, and directly addressAustralian concerns over the degree to whichthese enterprises are controlled politically.Pointing to Chinas considerable track recordof investing in Australia would be a good start.The Abbott government will also have to pay

more attention to public sentiments at home ifit wishes to get a trade deal with China withinthe year. Economic statecraft is an importanttool of Chinese foreign policy, worthy ofserious and sustained attention; but it shouldnot be used as an excuse for opposingeconomic engagement with China.

Conclusion

Chinese leaders sit astride the worlds second-largest economy, enjoying political control overvast swaths of the nations wealth. Thetemptation to deploy this wealth for strategicpurposes has proven irresistible. The allure ofeconomic statecraft for Chinese leaders derivesfrom their influence over Chinas massivedomestic economy. Yet the same two factorsalso undermine the effectiveness of Chinaseconomic statecraft. The dispersal of powerand diverging preferences across the

multiplicity of actors involved in the statesector results in incoherent and oftencontradictory approaches to economicstatecraft. Similarly, Chinas rapid growth andregional prominence exacerbates anxietyamong its Asian neighbours, generatingbacklashes and balancing responses across theregion. The lack of coherence within Chinaseconomic statecraft, Chinas domesticeconomic challenges, and Australiasconsiderable economic advantages all suggest


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that Australia is unlikely to find itselfvulnerable to Chinese economic coercion, evenas trade and investment ties deepen.

Acknowledgements

The author is grateful to Nick Bisley, AnthonyBubalo, Stephen Grenville, and Linda Jakobsonfor their comments and suggestions on previous

drafts of this Analysis.

NOTES

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Taiwan: a tricky weapon to use (Santa Monica:RAND, 2007); William J. Norris, Economicstatecraft with Chinese characteristics: the useof commercial actors in Chinas grandstrategy (PhD diss., MIT, Cambridge, MA,2010); Deborah Brutigam and TangXiaoyang, Economic statecraft in Chinas newoverseas special economic zones: soft power,business, or resource security? IFPRIDiscussion Paper 01168, March 2012; JamesReilly, Chinas unilateral sanctions, The

Washington Quarterly 35, no. 4, (2012): 121-33.4 Verna Yu, Has Beijing got what it takes tobe a global player? South China MorningPost, October 2, 2010.5 Liu Wei,

[New characteristics of internationaleconomic sanctions, and the countermeasures

China should take,] [Commercial Economic Research ] 28 (2008):32; Hu Yan, [An initialdiscussion on purchasing diplomacy,][Economist ], no. 2 (2008): 79-80.6 Liu Jianping and Liu Weishu,

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A BOUT THE A UTHOR

James Reilly is a Senior Lecturer in the Department of Government and InternationalRelations at the University of Sydney. He is the author of Strong Society, Smart State: The Riseof Public Opinion in Chinas Japan Policy (Columbia University Press, 2012), and the co-

editor of Australia and China at 40 (UNSW Press, 2012). He has published several bookchapters in edited volumes, as well as articles in: Asian Survey , China: An International

Journal , Chinese Journal of International Politics , Japanese Journal of Political Science , Journal of Contemporary China, Modern Asian Studies, Survival , and Washington Quarterly.

He holds a Ph.D. from George Washington University and an M.A. from the University ofWashington, and was a post-doctoral research fellow at the University of Oxford (2008-09).

Before that, he served as the East Asia Representative of the American Friends ServiceCommittee (AFSC) in China from 2001-2008.


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www.lowyinstitute.org