China’s “Economic War” Considerations

When Bill Clinton came to the presidency in 1993, he noted that the next world war would be economic. Since that time up through 2008, U.S. military expenditures were $6.023 trillion, whereas China spent only $667.1 billion on its military in the same period. In terms of GDP, the U.S. spent an average of 3.64 percent over that period while China spent an average of 1.89 percent. In that same period the U.S. spent nine times more than China did on its military and war fighting capabilities.[1]

As early as 1979, following Deng Xiaoping’s return to power, China’s transition from central planning to a market-oriented economy was coupled with a new policy of opening to the world, yet the West paid scant attention to the China’s five year plans and its major economic and numerous industrial development plans. It was not until the rampant offshoring of U.S. industries to China and other Asian countries began to cause significant job loss that politicians started to take note. Unfortunately, Western voter attention is drawn to China mostly during increasingly acrimonious election cycles when economic performance takes center stage. Defense industry lobbying in the U.S., although at its height in election years, is always ongoing, with the industry using fear, security, and the loss of jobs as its key arguments for high levels of defense spending. Yet the jobs argument is highly debatable. In a report titled “Military vs. Climate Security” released in August 2009, Pemberton argued that every $1 billion spent on manufacturing weapons creates 8,555 jobs. An identical investment in mass transit would create 19,795 jobs, and in weatherization or infrastructure would create 12,804 jobs.[2]

In 2009, using the electronics industry to illustrate key industrial offshoring causes and effects, Pecht and Zuga[3] noted that the West began significantly outsourcing the manufacture of simple electronics components in the 1990s. China seized the opportunity and positioned itself to grow an advanced electronics industry. With each new opportunity, China took advantage of the accompanying transfer of technology, engineering expertise, and management skills to develop a manufacturing capability that no other industrial base can compete with. Now the world’s businesses and consumers are dependent on China for what has become the “China Price” for electronics. The complexity of the electronics industry’s supply chain from raw materials to finished goods and the ubiquity of electronics in the 21st century means that price will remain paramount in every purchasing manager’s list of priorities, especially now in the face of the worst economic downturn since the Great Depression. But contrary to common belief, China has made no secret of its intentions to achieve this goal: China’s intentions are well documented in its economic and industrial policy.

In October of 2010 China used its control over the global supply of rare earths to curtail shipments of the critical rare earth supplies to Japan. This curtailment of supplies of rare earth elements (REEs) was in response to a maritime incident between Japan and China. Since Japan’s electronics and automotive industries are key to Japan’s economic well being—and since these industries are highly dependent on a continuous supply of REEs—curtailing exports to Japan was a logical economic weapon to employ.

China has continued to demonstrate its control over global REE supplies with its announcements that it will cut its export quotas for rare earth elements by 35 percent for the first six months of 2011. This threatens to extend a global shortage of the minerals, driving up prices and intensifying a scramble to find alternative sources. China’s announcements have driven the prices of electronics components to alarming new highs, and stock prices of Western REE mining companies have risen to unsustainable levels based on psychology rather than profits. As a result, this issue has been brought into the financial press mainstream.

For readers not familiar with the electronics industry and its dependency on rare earth elements, the rare earths are a collection of seventeen chemical elements in the periodic table which tend to occur in the same ore deposits as the lanthanides and exhibit similar chemical properties. The rare earths are essential not only to mobile communications and almost all aspects of our digital society, but they are also vital to all defense electronics, including radars, electronic warfare systems, and network centric warfare communications, which are all of equal importance to the conduct of modern warfare.

At this point it is important to note that the increasing demand for rare earths in advanced electronics applications and an increasingly competitive supplier base were forecasted as early as 1999. China’s increasing need for rare earths for the technologies fostered under its High-Tech Research and Development Program 863 was documented in what is now known as the Cox Report. [4] China’s Program 863 (State High-Tech Development Plan), established in 1986, was funded and administered by the government of the People’s Republic of China to stimulate the development of advanced technologies in a wide range of fields for the purpose of rendering China independent of financial obligations for foreign technologies.

By 2002, the USGS noted: “In 1999 and 2000, nearly all (more than 90%) of the separated REE [Rare Earth Elements] used in the United States was imported either directly from China or from countries that imported their plant feed materials from China. The surprisingly rapid progression from self-sufficiency prior to about 1990 to nearly complete dependence on imports from a single country today involves a number of causative factors.” This is why we should have been listening to our own analysts almost a decade ago.

In retrospect, then, we had early warnings of foreign control of rare earths. It is now estimated that 97 percent of REEs are owned by China. We must now face the reality that the West’s electronics production and our ability to produce hybrid electric cars and alternative energy systems, could come to a halt should China decide to curtail all access to these materials. As history shows, China’s government subtly provided long-term advance notice—through Program 863 and many subsequent government-instituted and published high-tech industrial development programs—of its need and intention to control the global supply of rare earths, seen by China as its own form of black gold.

Recognizing the successes attributable to its three decades of robust industrial policy and S&T investment, China has developed trade policies aimed at ensuring and controlling the supply of the natural resources necessary for rapid and sustained industrial growth. This has resulted in China gaining virtual control over the rare earth materials critical to advanced electronics.

In response to China’s latest announcement regarding the cutting of export quotas for rare earth elements, on December 30, 2010 Martin Hickman of the U.K. paper The Independent noted that “the announcement caused dismay among Western governments, which have belatedly begun to appreciate that China’s stranglehold on elements such as lanthanum, used for batteries in hybrid cars, and neodymium, for permanent magnets in wind turbines, give it immense economic and political power.” This is the first and only admission that the West was needlessly surprised when all the warning signs were there more than two decades ago with well-documented Chinese industrial policy.

On January 11, 2011, China once again delivered on its published intentions by unveiling its new stealth fighter, the J-20. After months of speculation and downplaying of China’s capabilities to produce such an aircraft, China’s radar-eluding stealth fighter made its first-known test flight on January 11, marking dramatic progress in the country’s efforts to develop cutting-edge military technologies. The J-20’s successful demonstration of flight was timed to take place alongside of U.S. Defense Secretary Gates’ visit to China in an attempt to coax China into greater transparency in defense and security matters. Despite the challenges of both stealth and engine technologies, the J-20’s entry into the test flight stage seems to indicate that China is progressing faster than expected with the new technology. As reported by the Associated Press, analysts have said that two prototypes have been developed, with one employing a Russian engine and the other a Chinese-developed engine, something that just a few years ago the U.S defense intelligence community did not think would be possible within the next three decades.

China has made no secret of its aspirations to become a serious competitor in the global aviation industry. As reported by Jane’s Defense Weekly in August 2010, the Aviation Industry Corporation of China (AVIC) is planning to acquire additional aerospace companies in Europe or the United States. AVIC, which is investing heavily in developing facilities at Zhuhai airport, is considering foreign acquisitions as part of its plan to become a global aviation leader to compete against companies such as Boeing and EADS. AVIC Commercial Aircraft Engine Co. is also building an engine research and development facility to develop engines for domestic-made jumbo jets in Shanghai. The center is responsible for developing homemade engines for the 150-seat C919 and a 250-seat model to directly challenge the Boeing and Airbus dominance of the large commercial aircraft. The center will have a floor area of 300,000 square meters costing $473 million U.S. dollars to build and will be finished in 2013.

In her aptly titled essay, “The Game Changer: Coping With China’s Foreign Policy Revolution,” Elizabeth Economy makes a solid case that China’s new agenda will require far greater attention to the country’s internal dynamics and a much more activist, coordinated foreign policy effort. Economy reviews China’s transformation over the last three decades and points out that “China’s leadership is poised to launch an equally dramatic set of reforms that will once again transform the country and its place in the world. If all goes according to plan, in 20 years or less, China will be unrecognizable: an urban-based, innovative, green, wired, and equitable society.[5] That may sound dramatic given China’s progress to date as well as the domestic social and environmental fallout from that progress.

To even casual China watchers, Economy’s summary of China’s transformation should come as no surprise, but a quick review here is warranted:

Beijing is investing hundreds of billions of dollars in the clean-energy sector and is providing subsidies to domestic manufacturers to encourage the sale of clean-energy products.

Already, China is among the world’s leading manufacturers of wind turbines and photovoltaic panels, and it is poised to capture significant segments of the global market in clean-energy transport, including high-speed rail and electric vehicles.

China’s urban population will be wired. China is already in the midst of an information revolution. Over 30 percent of Chinese people use the Internet, and most of them are in cities.

China will construct 20,000–50,000 new skyscrapers over the coming decades.

Connecting all these and other new cities throughout the country will require 53,000 miles of new highway.

Once the cities are built and connected, the demand for resources will continue to grow: urban Chinese consume more resources than those in rural areas (roughly 3.5 times as much energy and 2.5 times as much water).

By 2050, China’s city dwellers will likely account for around 20 percent of global energy consumption.

Tens of thousands of Chinese companies now operate throughout the developing world, often rejuvenating previously moribund economies with their investments.

Relating to Economy’s last point, China’s outward globalization was summarized in a 2009 research report published by Shaun Rein, the Managing Director of the China Market Research Group (CMR):

Over half of the smaller industry leaders interviewed had already begun moving overseas or planned to begin to do so within the next five years.

100% of large industry leaders interviewed have already started moving abroad, as have 80% of smaller leading companies.

80% of large industry leaders interviewed consider building their brand image from domestic Chinese to a global name brand to be their primary goal in expanding abroad.

All respondent companies planned to establish more R&D centers abroad to better utilize the talent and technology advantages there.[6]

China-Africa Trade Brings Mutual Benefit

China’s global outreach to companies stressed by the economic crisis in its quest for technology transfer may appear callously opportunistic, but to China it’s just good business sense. Africa serves as a case in point. In Africa, as in South America, China espouses a business pragmatism foreign policy of “nonintervention in domestic affairs of partner trading nations.” China has a long history of providing aid to African countries as a means of building goodwill and support. In 2007, Andy Scott of the journal China Briefing reported that Chinese engineers have provided African countries with technical support for infrastructure projects and its doctors help with the treatment of AIDS patients. In countries like Chad, Angola, Sudan, and Zimbabwe, China has frequently outbids and outgiven more established Western players. By 2005, Beijing overtook the World Bank as the leading lender in Africa.[7] People should have listened to Andy Scott. China continues to invest heavily and broadly in Africa.

Although China-Africa trade volume dropped to $91.07 billion in 2009 as a result of the international financial crisis, China became Africa’s largest trade partner that year for the first time. From January to November 2010, China-Africa trade volume reached $114.81 billion, a year-on-year growth of 43.5 percent. By the end of 2003, China’s direct investment in Africa reached $490 million, and rocketed to $9.33 billion by the end of 2009. Second, wide distribution: China’s investment in Africa is distributed in 49 Africa countries, most prominently in South Africa, Nigeria, Zambia, Sudan, Algeria, and Egypt. Third, wide range of areas: China’s investment in Africa covers mining, financing, manufacturing, construction, tourism, agriculture, forestry, animal husbandry, and fisheries.

The Trade Cooperation Zone was the first overseas economic and trade cooperation zone launched by China. So far, 13 companies have moved in. They engage in mining, prospecting, nonferrous metals processing, chemical engineering, and construction. They’ve made investments worth $600 million, and provided more than 6,000 jobs for local people.

The good will and influence associated with China’s heavy involvement in Africa are not lost on China’s defense industrial base. China produces a full range of weaponry which, though they may not be as sophisticated as American and European systems, they are perfectly adequate, less costly, and quite capable for its developing world client states, African nations among them.

Of China’s 2009 arms sales, nearly 80 percent were sold in Africa and with those sales came influence and industrial partnering. Egypt is home to a small but increasingly capable electronics industry, and now with China’s help it is poised to climb the supply chain ladder a bit higher. In early January of this year, AVIC and the Egypt-based Arab Organization for Industrialization (AOI) signed a collaboration agreement to jointly develop and produce a range of Chinese-designed equipment for the Middle East market. The cooperation will include the development of aero engines and avionics technologies as well as unspecified electrical and mechanical components for the aviation sector. The partnering is likely to be focused on both commercial and military markets. AVIC and the AOI have also established an aircraft maintenance center and an aviation research and development facility designed to benefit Egyptian industry.

But that is not all. The agreement also outlines joint programs to develop renewable energy platforms, construction vehicles, and agriculture equipment. AOI engineers and technicians will also undergo training with AVIC in China. The AVIC-AOI agreement is also representative of the Chinese group’s bid to increase its international presence in the next few years. Target markets include the Middle East, Africa, Asia, and Latin America. As reported by Jane’s, the Chinese government fostered the AVIC-AOI agreement, which is designed to not only increase revenues but also enable AVIC to access foreign technologies and enhance corporate acumen in international business strategies.[8]

2010 Year-End: China Technology

In closing, lest there still be any doubt about China’s increased influence in global political and economic affairs, a quick review of just a few of China’s more notable technological achievements last year is warranted. In 2010:

China completed 15 successful space launches, including that of its second lunar probe, Change-2, which will determine a site for the country’s first unmanned moon landing around 2013.

China also sent five Beidou navigation satellites into orbit as part of the country’s plan to have 12 Beidou navigation satellites form a network covering the Asia-Pacific region before 2012. The system will have 35 navigation satellites by 2020, when it will rival the United States’ Global Positioning System.

China became the strong player in the global high-speed railway industry by innovating upon technologies previously imported from Germany, France, and Japan. The Ministry of Railways announced last year that the nation’s high-speed railway network had reached 7,531 km, which is a longer network than in any other country.

In September 2010, a Chinese-made train reached 416.6 km/hour on the Shanghai-Hangzhou high-speed railway. Two months later, a train on the 1,318-km-long Beijing–Shanghai high-speed railway beat that record by reaching 486.1 km/hour. CSR Corp Ltd, a major domestic train manufacturer, is building an experimental train that would challenge the 574.8 km/hour speed record set by a specially configured version of France’s TGV in 2007.

The Ministry of Railways started out with the strategy of “innovating on the basis of imported technologies” to form their own system. The Chinese ministry has now filed 947 patent applications in the country since March 2010 and had also started filing applications for intellectual property rights abroad. Meanwhile the United States is still considering where to implement a single high-speed rail line for a possible California project.

China’s achievements in the deep sea have made it the fifth country to develop deep-diving technology capable of going beyond the 3,500-meter mark. In particular, the domestically developed submersible Jiaolong planted a Chinese flag on the bottom of the South China Sea during a 3,759-meter-deep dive in July 2010. The vessel, designed to reach a depth of 7,000 meters and operate in most of the planet’s oceans, is considered the world’s only manned submersible that can theoretically reach those depths. Japan’s Shinkai 6500 can dive to 6,500 meters. The other three countries with deep-diving technology are the United States, France, and Russia.

China overtook the United States in developing the fastest supercomputer. The Tianhe-1A can perform 2,507 trillion calculations per second and is 29 million times faster than the earliest supercomputers. China is also developing power systems to address the needs of such supercomputers.

Innovation had been culturally inculcated in China’s academic and industrial classes long before President Obama started to talk about it., Innovation in research and development and manufacturing is fully encouraged by China’s government and has been for more than a decade. According to the Paris-based Organization for Economic Cooperation and Development (OECD), China’s investment in innovation nearly doubled from $44.6 billion in 2006 to $89.7 billion in 2009. The country’s spending on innovation is now growing at 25.5 percent a year, compared to a decline of 4 percent in the U.S. in 2009. Yet even greater sums have been poured into infrastructure development. For example, the budget for high-speed railway construction in 2010 was an estimated $105 billion.

Conclusions

China has listened to Bill Clinton. China’s economy is growing faster than any other country of its size, and China is making sure that this is sustainable. China has invested heavily in innovation and infrastructure, and is developing the foundation necessary to ensure a measure of economic control, which may prove stronger than any military strength. Today, most countries owe China, and also depend on China. Meanwhile, China is developing a foundation so that they will not need to depend on anyone. Perhaps the U.S. should rethink its strategies of rare earth materials, high-tech transfer, and outsourcing of manufacturing and debt to China.