Welcome to Asia2025….

I’m Maryann Keady - and today on the program we’re going to look at the economic competition between China and the United States – as well as the footprints of China in East Timor – and what that means for the young country.

Welcome back to the program.

Well the economic competition between the United States and China has been in the news in the United States for the last few years. Conservative politicians lament the flood of cheap Chinese exports, and claim that it signals the death of the American economy.

There is no doubt that the growing regional hegemon is challenging the economic might of the American empire. Chinese growth in the last few years has averaged around 12%, and everyone from financiers to furniture makers have flocked to China, not only to produce cheap goods with cheap labor, but also to try and win their fair market share of a burgeoning economy.

China’s population – thus potential consumer base of course, stands at 1.3 billion people.

But how robust is that economy, and with recent market jitters, how can it avoid imploding?

Last year while in America, I spoke to US economist DAN ROSEN, Principal of China Strategic Advisory; and Visiting Fellow at the Institute for International Economics and an adjunct Professor at Columbia University.

He challenged many of the myths surrounding the US economy and China, and had very interesting things to say on some contentious issues.

Such as the US pressure for a revaluation of the Chinese currency which has dominated economic talks between the two countries, the link between the political and the economic in Washington’s eyes, and the hi-tech dreams of the economic Asian dragon.

I began by asking Dan Rosen, how significant the Chinese economy was as part of the larger global economy:

DAN: China’s move from being an autarky, where it had absolutely zero weight in international trade, in 1980 it had withdrawn itself entirely from the international economy, to a position where it is larger and growing at a very rapid clip, so when you look at the international trade system, the economy, China’s a pretty important weight today. But coming from a low baseline, so it’s the slope of change that’s most important about China, and think about China on a population weighted basis and they have still a long way to go before China’s trade weight is punching the same as its population size.

ASIA2025: But what about compared to the United States economy? How significant is China within the global economy?

DAN: When we compare it’s GDP size, it is puny compared to the States or Europe. Its small even compared to Japan, right? China’s economy is about five or six percent of the global economy, US is just shy of 30% Europe is 30% Japan is about ten percent of the global economy. So in absolute terms, nominal terms the Chinese economy is still very small.

ASIA2025: Why is there so much, so much rhetoric, about this strong incredible Chinese economy? What is that about?

DAN: I think part of it is human psychology, I think people notice changes at the margin, more than they notice absolute levels, or current size or something. There could be a nuclear power plant right down the street from your house, and if someone installs a coal burning stove right next to door to you, you all of a sudden make a big deal about it. As if that is a real imposition on your quality of life. So part of it is just human nature I think, it’s the fact that China is changing so quickly, at the margin of what we already expect the world to be that it is giving us some anxiety’s.

And then looking to – if we took a ruler and drew a straight line between what Chinese consume today, and what their resource intensity would be, five, ten or fifteen or twenty years from now, if their amount of copper per person were anything like that of Australia or the United States, then we start to get to some very scary scenarios very quickly, both in terms of our competition for resources in the world and the atmospheric consequences for the environment of the Chinese consuming as much stuff as the typical American or Australian would.

ASIA2025: How big are China’s imports to the West? Because this has of course been a huge domestic issue that ‘we are being swamped by Chinese goods.’ How significant are those Chinese imports to the United States?

DAN: Significant. So there is political significance, there is consumer significance - there are a lot of different considerations. Politically it is very important.

Singularly, it is one of the main drivers of trade policy in Washington today, even on non-China trade related issues. For instance whether we renew trade promotion authority for the President, which our Executive Branch needs in order to quickly propose law and get it started, whether we are talking about doing an FTA with Colombia, or with South Korea, all these things are motivated or affected in one way or the other by the Washington discourse over the role of China in the world, so politically significant.

For the American consumer also very, very significant, especially among poor Americans that have a huge boost in their purchasing power or as a result of lower prices for quality goods, low end stuff that comes out of China that they wouldn’t have otherwise. And the other so called objective economists analysis though, the share of the American trade deficit that is with Asia including China today is actually lower than it was ten years ago vis-a-vis Europe, for example and the rest of the world…which is to say China is a much bigger single line item in our trade story with Asia, but Asia as a whole hasn’t become a bigger line item in our regional comparison of our trade position worldwide.

You know its been basically reduced to an aphorism or something already today, that China is the ‘final assembler’ of higher value added stuff, that is generally made in the rest of Asia and then sent onto the US from the PRC. But most of the value added at the end of the day still isn’t landing in China, it’s landing in other places. China will run a trade deficit with Taiwan in 2006, probably 60 billion dollars, so of the US household dollars spent on Chinese quote-unquote goods, all of this money spent to the so-called communist Chinese, the communist Chinese are going to turn around and send 60 billion of that to the rebels on rebel Taiwan, which makes for a rather more interesting and complicated story than many people think.

ASIA2025: I want to come back to what fuelled Chinese growth – because I am sure you have said once before that India and China have the same supply of cheap labor, yet everyone talks about how China has grown and it’s so significant because of its cheap labor. You seemed to be indicating that the Indian economy did not grow as quickly so it cannot be just cheap labor.

What fuelled Chinese growth – and how important is cheap labor?

DR: India has a billion people, China has 1.3 billion, so and India does not loom as nearly as large in our ids as a fear factor the way that China does, so its obviously not about just having a lot of people, there is a lot of people in Africa. There are a lot of people in a lot of places, who aren’t being very productive. It’s what those people can do within the context of an economic system. What has fuelled Chinese growth there are many, many things we can talk about.

But the headline for me I think when millennial history is written is structural adjustment. Structural adjustment means that the political conditions are present that allow resources to be shifted away from one endeavor, to other endeavors. So that capital, land, labor – all the things that get mixed together in economic activity, can get taken away from what used to be done and devoted to new things, that weren’t done previously. So in the case of China, we started out in 1980 nearly one hundred percent state controlled economy. Today the state share of the economy is well under fifty percent, so that has meant a huge creative destruction of old economic activity so that resources could be freed up. That hasn’t happened the same way in India.

India has a much tighter cultural condition, didn’t go through a cultural revolution, didn’t tear out the roots of families and communities that China did, over the course of a nearly hundred years of turmoil, and so has a political system that takes a lot more time to permit and make way for dramatic changes in the economy. Whether it is the entrance of foreign competition into the Indian economy, whether it is using imminent domain to take farm land away from people so that freeways and power plants and ports can be built, so you really can’t blame India for that, it really comes down to a matter of values or at least different political systems, where there is no objective answer to which is right and which is wrong. But the ability of China to facilitate that kind of change, that structural adjustment, that dynamism, is very much about very much helps us why the growth rates have been so different.

We can talk about what I call second order effects, such as the fact that China now has a hundred and seventy-four cities of a million people or more, is over forty percent urbanized already, whereas India a few years ago was more urban than China. Today China is radically more urban. Urbanization almost always results in higher output and productivity per worker, cause it means you have more concentration of people in a factory setting rather than individuals working on the land. So you can point to the urbanization driver in China. But what has permitted urbanization to take place – well that is the result of a political system that permits farm land to be converted into cities, which permits them to move far away from their villages and be part of a different kind of economy.

ASIA2025: I know it is a long bow but do you see advantages in their political system that that has allowed them to make vast changes, without the protests and interest groups that are here in the United States?

DAN: Well I think the political system in China permitted this sort of rapid growth, whether you think this sort of rapid growth is the principle calculus you should use in determining which is ‘better’ or which is ‘good’ and which is ‘bad’ which are not concepts…

ASIA2025: No, I was thinking in purely economic terms…

DAN: Even in purely economic terms, we don’t even have a proper accounting of how much environmental damage has taken place in China. If you wanted to be a very progressive economist, and try to factor in all those externalities, environmental effects, you might find that while the growth in China has been dramatic, has in the long run done more damage than it has done good, because it was a command and control unaccountable government overseeing this whole process. And maybe an India that takes a hundred years, to get to the point where China got in twenty years, seen from the perspective of a hundred year point of view, end up whose view of superior and whose inferior may look different.

But from the perspective of individual human beings, who’ve seen their incomes quadruple or better over twenty years time, I think it is fair to say from their perspective, the approach to governance and politics that China has taken has been more effective at alleviating more poverty than India’s.

ASIA2025: What areas are they dominating? There has been much discussion of high tech areas – are they dominating the high tech areas, or is there skill simply assembly of foreign parts of a finished product to be exported elsewhere?

DAN: We have pundits in the United States like Lou Dobbs for example that reach a lot of people, and seem to take this line that China has this high-tech technology which is going to lay the American economy low even in high tech, sometime very soon. And this is usually followed by the fact that this is the result of them usually pirating or stealing or counterfeiting American technology, or American companies giving it away stupidly.

You can actually find very little evidence that this is true or holds much water, the great, great majority of Chinese economic activity, both for export and where their activity has expanded for internal consumption is in very low technology, labor intensive manufacturing and assembly work. You can point to very few examples of China getting anywhere near the cutting edge, as the global cutting edge is understood. For that matter, even what was cutting edge in the 1980’s say in terms of technology, is still pretty challenging for Chinese firms.

Where high tech or higher tech is being done in China, it is almost always under foreign management and ownership, which is to say, Taiwanese manufacturers that have set up in China to use Chinese labor along with know-how and machines. European companies, American companies, set up in China to manage and oversee higher technology activity. Those Chinese firms which most are associated with high tech today LENOVO are trying to grow their capabilities more by acquisition of foreign capabilities more than developing it indigenously and organically.

There have been more very high profile scandals and failures of high tech than there have been success stories. The most notable of which was supposedly an indigenous computer chip designed Jao Tong University which turned out to be a Motorola chip with the name Motorola scratched off it, and Chinese characters engraved over it, like as if you were scratching off the vehicle ID off a car so that it couldn’t be traced after you stole it.

ASIA2025: So the strength coming from where in its economy sector?

DAN: Well, it’s growth is coming from labor intensive manufacturing activity, infrastructure build up, so that in turn means investment, and that’s playing a very large role in the Chinese economy.

ASIA2025: Domestic or foreign investment?

DAN: Domestic. We are talking now of about 55 to 70 billion dollars of FDI or Foreign Direct Investment going into China, which is a large number compared to all other developing countries, even compared to developed countries, but that is seventy billion compared to 700-800 billion a year or more of investment in the economy, so it’s well under ten percent of Chinese investment abroad.

ASIA2025: How important is energy in this? A preoccupation it would seem of China – and the US, for strategic concerns as well as anything else. How important are the external energy sources for China, and how much supply does it have domestically?

DAN: When we talk about energy let’s talk a little bit about oil, natural gas and coal. We can talk about nukes as well, I think that may be of interest Down Under as well as you guys are a big uranium producer, potentially for China in particular. Starting at the top, China was a net oil exporter until 1992-1993, it’s only since then that they have become a net importer. Small at first, and now really pretty big. Compared to the amount of energy that the United States consumes China is still small. But they are gaining on us rapidly, they have a big population, and they are going to rely heavily on international markets both for oil and and natural gas for sometime to come. There is almost no scenario where they are going to be able to get away from that dependence on the rest of the world to help meet their energy needs.

On the coal side, coals probably 80 percent of its total BTU – total energy that it consumes, coal derived energy, there are ambitious goals to reduce that dramatically in the years to come, because its got nasty environmental consequences. I think the hope was that natural gas could step in and play a really important role in generating power for China.

Natural gas markets have changed dramatically over the past two-three years. The price of gas has changed, China has essentially turned its back on the possibility of using gas as a means of a major power source in the years ahead, so that is off the table. Nuclear is something that China is going to do a lot of in the years to come. Probably bill 25 to 35 gigawatts of nuclear power that means 25-35 power plants or facilities. That is a lot. That’s going to be a big share of the new marginal power bill in the world in the coming two decades. But still compared to the total needs of China, it can’t possibly be more than five or six percent of their total power needs in the years ahead.

Oil is expensive and it’s not going to get cheap anytime soon most people think, and I am among them by the way, your left with coal. So as much as China has ambitions to reduce its coal propensity, it really is going to go the other way and stay at or above its current coal intensity in the decades ahead, which raises a lot of challenges for them. They talk still a lot about reducing their energy intensity, per dollar per GDP output, I think they are being overly optimistic in how quickly they can get Chinese companies to do that. They’re not going to be a service sector dominated economy in any time soon. In fact they are getting more and more industrial as we shut down our dirty industrial plants from Ohio and send them to China. Europe does the same thing. Whether it is steel or aluminum or any other any other industry that is particularly nasty, a lot of it is going to China.

So they’re not going to become a lot more efficient in their energy use any time soon. They’re not going to be able to change their energy mix as I say, anytime soon. They’re probably going to use more coal and turn it into gasoline and diesel. What is called coal to liquids, which is potentially a new source of car fuels coming from coal as opposed to oil. So the energy picture is a complicated one, there is no way around energy insecurity for them, on a geo-political basis. There is no way away from an environmentally dirty future, with the dependence on coal, and there is going to be a lot of consequences for them both environmental and political and economic.

ASIA2025: What about the issue of water – is that something that feeds into the economy?

DAN: Well water is a big issue for China, has always been. Some people argue that the evolution of government in China 3500 years ago was in small part about water, managing water resources for people. The Grand Canal runs from central China to north China, is an example of a great water works that was a signature achievement of government thousands of years ago and it still is today a tremendous challenge for government today to deal with water problems. China has a lot of water in the aggregate. But there is an old joke about an economist that drowned in a river that was one inch deep on average. Meaning you can have a lot of water where you don’t need it and not enough where you do need it.

Giant chunks of China are short of water, including Beijing and much of the north. There are massive infrastructure plans afoot to divert water from the south of the country to the north, who knows what the ecological side effects are of moving so much of the river flow to north are going to be. There may be political consequences, in peninsula south-east Asia, with Cambodia, Vietnam, Thailand for instance, reducing the water flows into that part of the world to take care of Chinese needs.

Efficiencies are still very low, the water that they have is terribly polluted, very little of it is treated, either for human biological agents in used water, or heavy industrial agents in that used for commercial and industrial purposes, so huge amount of work to be done, gargantuan budget outlays. Yesterday I think penciled in 150 billion dollars to be spent on water remediation during this five year plan, for the next five years. That is probably just a starting point in terms of what they are going to have to spend to deal with their water issues.

ASIA2025: Are they looking at any alternatives other than the coal-to-liquid?

DAN: Don’t say ‘other’ than coal-to-liquids, because coal-to-liquids has a major water implication that we do need to talk about. One of the steps in turning coal and into useable liquids and chemicals, whether it is you making gasoline, diesel, naptha – all these things you can make from coal all require that you was the coal quite heavily before moving into these processes that generate other products at the end of the day. So coal to liquids itself can be a very intensive undertaking.

Generating power from coal requires low sulfur coal to reduce sulfur emissions, that is very water intensive, so coal is not water friendly by in large. And where the coal is in China is generally not where the water is- there are some exceptions to that. But generally speaking it is a big problem. If there were something easy to turn to, that was not water intensive, surely China would be doing it. The only thing that nearly meets that criteria and only for electric power generation is nuclear. But there again the problem is that Chinese chemical plants tend to blow up every now and then, and spill nasty chemicals and benzenes, and destroy rivers, both flowing domestically and some flowing over borders into neighboring countries.

I think Beijing is necessarily anxious about the notion of having even thirty-five nuclear facilities around the country, let alone having a hundred or more. Accidents will happen, and in a country where people routinely cut corners, whether it is on training, or the service component that runs up the cost of these things, that is cause for real concern especially in a nation that had such incredible population density as China does. So, some amount of nuke is going to be embraced, it has to be, but that comes with an awful lot of anxiety.

What are they left with? There is geo-thermal and wind, and these kinds of things. They’ll do as much of that as they possibly can too, but even in the most optimistic scenario that is going to make up just a tiny drop of China’s total energy needs.

ASIA2025: What about the 350 million farmers in China. There has been a mass relocation – and I think that is still going on from the rural areas, what does that mean, and what does that mean from an agricultural reform level?

DAN: Good I am glad you said 350 million because some people sometimes look at the stat for rural Chinese, which is at 850-900 million, and assume that that is the number for farmers, but its not actually it’s only 350 million in farming.

Most agricultural economists would speculate that at the end of the day, if China were totally adjusted and efficient on the agricultural side it would need to have about 150-200 million people in agriculture. As we’ve said probably 350 million today, we’re seeing ten-twelve people a year move into rural jurisdictions to urban jurisdictions, so we’ve been slowly, while that doesn’t sound like a small number to an Australian probably where that is half the population or a third anyway. But in China that has been the pattern for a decade or more now. So that’s just business as usual. They can handle the pressures of that level of migration, hasn’t been that disruptive to move the people, what is more disruptive is when the city moves out into the farm, rather than the farmers coming into the city. When the city moves out into the farm, then we are taking active farm land away from people who want them to stay there and converting it to some other use, whether commercial or industrial. Or maybe residential property development or maybe a golf course too, which shouldn’t be happening nearly as much as it does, but happens.

That can lead to social instability, when you take people’s property away, that’s not their property because they don’t own it. Nobody owns land China, but they are supposed to have tenure rights for a period of time and those are often arbitrarily shortened in a way in which can be destabilizing in a local area. Nationwide we do not have social instability and unrest in China. We simply do not. But we have pockets of unrest and instability in areas where that line between the town and the country gets closer and closer together, and ultimately there are clashes that arise from that.

Overall in terms of agriculture efficiency, China is really pretty good. It can feed itself, it should shift away from trying to grow everything it consumes and instead grow the things it can be most competitive at, shitake mushrooms for example, rather than grain, rather than grain intensive livestock for meat and these sorts of things. So there remains to be a lot of adjustment in Chinese agriculture, but it has pretty much moved in the right direction. And it has got competitive enough that we need to be worried in the US for example about the long term fortunes of Washington State, Oregon State and North California, which are big vegetable growing regions of our country. That’s very labor intensive. We have to import Mexican workers each year to pick that stuff. China does not have to import Mexican workers, they’ve got plenty of their own Mexicans, so to speak. They’re called Chinese, and they’re delighted to grow broccoli and make two thousand dollars a year, rather than being told that they have to grow all their own grain, in which the might make eight hundred dollars a year or something like that.

So it is that structural adjustment away from crops they shouldn’t be doing towards things they should be doing, where welfare gains lie and they’ve already shown that they are willing and capable of making those adjustments.

ASIA2025: A question that dominated the first half of this year, of China being a ‘currency manipulator’, the idea that China has this trade advantage and they had to deal with their currency. What would happen if they did push the value of their currency up? I know now they have changed and it is pegged to a basket of currencies, but what would the effect be, and are they likely to keep revaluing their currency?

DAN: Whether I want to talk about it or not it seems these days I have to. A couple of things – a preliminary, the econometric efforts to objectively answer the question whether the renminbi China’s currency is severely misaligned against other currencies, that econometric work is ambiguous at the end of the day. It is very difficult to say with any real certainty, that the renminbi is ten percent, twenty percent, forty percent undervalued against the US dollar. Nor is anyone suggesting taking off all controls whatsoever and letting some pure idealistic market system decide where things end up at the end of the day. Nobody does that really, nobody is doing that, and nobody is suggesting that.

So what we’re talking about is what mix of flexibility and restraint is appropriate for China for the time being. People get attached to the things that matter most. There are a lot of things that matter in life. But a few things end up mattering most and in trade and development a stable exchange rate, one that is not necessarily undervalued or misvalued, but one that foreign investors and domestic producers some amount of predictability about what the rates will be next year. So that they don’t enter into this constructing of factories, planning relationships and retail links only to find what they are planning to do is not competitive at the end of the day because of some radical change in exchange rates. That is very important – that is one of those can’t forget points, that is very hard to shake out of Chinese minds and anybody else in Asia. So the notion of stability first and foremost is deeply engrained.

That said having a currency which never moves can be dangerous too. Inflationary pressures can build up behind it, foreign exchange reserves as China has today of nearly a trillion dollars can become a big problem, it’s the kind of problem that most people would like to have, but it’s a problem nonetheless that can have corroding macro-economic effects on an economy which over time become more and more dangerous to the ability and sustainability of an economic model.

So if I have heard correctly, I have heard Beijing that they recognize that the exchange rate system needs to change over time, but they want to do this in a gradual way that doesn’t create additional instabilities for particular vested interests in China in the meantime. They are probably not as adequately sensitive to foreign political considerations because foreigners have political sensitivities here too. And clearly Beijing has not made those its top priority.

My own view is this – yes, we’ve seen a moderate amount of appreciation of the Chinese currency over the past year and one month now, from 8.21 to the dollar, to 7.95 or so today. Most people think that it might go to 7.5 or 7.8 by the end of the year, most people who say that, are saying there is not going to any change from current stances on this from Beijing. They’re going to permit very little movements each month, which they describe as a ‘widening of the band’, saying it could go either way.

But at the end of the day, what that means is that there will be these tiny, tiny steps each month, month in and month out, this year and next. No-one has a crystal ball and no-one knows whether the consensus in Beijing will change, and whether they will decide to take a more dramatic step in that direction sooner than folks think. That is not characteristic of their behavior in any other economic regime over the past twenty years, they tend not to do that, but every now and then an inflection does happen, whether on tariffs or as we saw last July on the exchange rate, or in any number of things.

What I think is very important to consider, are a couple of caveats first of all. First, the assumption that the currency has to move up against the dollar or basket of currencies has been predicated on the assumption that there is not an open capital account in China. That money only flows one way – its like a ‘roach motel’ they check in and they don’t check out, well dollars check in and they don’t check out because people aren’t allowed to diversify their savings portfolios out of China, and able to invest their money in Macquarie or Newburger Berman here in New York or something. That assumption is now already out of date. Windows for Chinese to go through something called ‘qualified domestic institutional investor accounts’ that are already opening. So if you are Chinese you can buy a mutual fund that is going to be invested in New York now. So some of this foreign exchange and Chinese renminbi wealth is going to start looking for dollars, and move out of the other direction out of the country.

It won’t be capital flight, it will be just portfolio diversification, which is a very rationale and reasonable thing to happen. That is going to press a little on the renminbi in the other direction in fact, as more renminbi get traded in for foreign currencies, so that people can buy foreign mutual funds abroad. That’s the first caveat.

The second caveat is even a thirty percent or forty percent revaluation of the renminbi would save practically not a job in the United States. It would open not one manufacturing facility in the United States, Europe or Australia. There are is a long line of economies right behind China looking forward to the opportunity to supply the US with Chinese bras if Chinese bras for whatever reason stop coming into the United States. So that’s the second caveat to pay attention to.

The third good point made by a fellow called Steve Green who is now at Standard Chartered in Shanghai, is that we haven’t looked enough at what we call the ‘elasticity’s of demand’, which is to say lets say that the price of a Chinese cigarette lighter did go up by ten or fifteen percent, we’re talking about going up from fifty cents to fifty six cents a lighter. Is that going to reduce the flow of lighters going into the US, or simply increase the prices Americans are paying, and lead to a larger deficit with the Chinese? That is a very tricky econometric story to tease out fully, but it is definitely something that we need to be thinking about.

ASIA2025: What about this idea, the old argument that the foreign currency reserves gives China some sort of leverage over the US, in terms of holding those currency reserves. The idea that China could do something with these (like dumping these reserves and thus push down the value of the dollar) if there was some sort of conflict.

Is that at all valid?

DAN: This is the sort of question that is very, very difficult to come up with a clear answer and it is not going to go away. People are going to continue in popular lay circles to talk about whether China has leveraged by virtue of its four-ex reserves for a long time, but if you were to play a game, do this like a game of risk or something, like that. You set up the scenario and you work through ten rounds where a conflict starts, China threatens to do this, US calls their bluff, they actually do try to trade in 400 billion of their dollar holdings – not all their trillions in holdings is dollars, mind you. We don’t know exactly how much but probably more like seventy percent than 100 percent, and again, a big chunk of that has to be held in perpetuity against import cover. So they don’t get into a balance of payments crisis god forbid, who would want to deal with that. So the amount that they have to play with, even consider a kind of an option - that kind of leverage is smaller than people think.

And when you start gaming it out and thinking about what would happen if this ever came to pass, it would be pretty rough. It would do some damage to US financial markets and everybody else’s in the world, because by temporarily destabilizing the dollar, or the treasury bill market, the pain would not just be felt by Americans, it would be felt by everybody, not least the Chinese of course, because they would be reducing the value of their own dollar holdings, presumably by taking a step that was damaging to the treasury bill market and the US market. But not just themselves – they would hurt everybody everywhere – they wouldn’t make many friends anywhere, that would be the static. Bottom line – it would be tough for the US but within three months it probably would have been absorbed and we would be back to business as usual in the US.

Looking at it dynamically, what would never ever, ever be the same again is China’s ability to lobby in Washington, or try to develop an agenda in good faith. The steps that the US would start taking to diversify our trade dependence away from China as a result of them taking a belligerent step like that would be catastrophic for China in the medium term, not even in the long term. Well within three years there would be a pronounced change in trade and economic policy in the US – there would HAVE to be, just think about it.

That is such an act of an aggression in a globalised economy that despite whatever costs were entailed, it would basically be a 9/11 moment for the US, in terms of its trade and economic policies toward China, and it’s just unimaginable to me that China would find circumstances in which it was willing to pay that cost of closing the door on the golden goose in an international economic system it currently enjoys.

ASIA2025: I am going to end on a Lou Dobb’s idea, this idea that China is taking away the US manufacturing base. What is your view of what the US should do to counter China’s manufacturing strength – should the US find other ways to compete?

DAN: Well you have spent your time in the States well, and I need to get out more because I didn’t realize that we had a manufacturing base left. I thought we were already about an 82% service sector economy, the remaining 15% of our economy which is still industrial or manufacturing oriented, most of that has been through four or five waves of globalization dating back to Japan and the 1960’s, through the rest of Asia through the seventies and eighties, and Mexico via NAFTA in the 1990’s and on and on. And China of course into the nineties and current years, so we don’t have much in manufacturing, what we do have is pretty battle hardened I would say ‘inoculated’ against low end competition.

Not all manufacturing is labor intensive, quite a bit of it is profitable, valuable value-adding parts of manufacturing which practically employ no labor. Take semi-conductor manufacturing – labor cost of goods sold is probably 2% -1% of the bill, for making a chip at the end of the day. China’s trying to make chips, but when it comes to making chips, China doesn’t really have an advantage over the US, we’re on a pretty level playing field. You can’t throw more cheap labor at semi-conductors and get a leg up on your competitor.

Bottom line – I am not too concerned about what we have left of US manufacturing, and I am not too concerned about those pockets like textiles which are still under a shadow of threat from China and other low cost labor countries.

There was a famous ad in the Washington Post during a trade debate in Washington a few years ago, showing a US soldier as he would look if only he could be equipped using only US manufactured product and he did not have anything left but his underwear which was still being made in North Carolina, his shirt, his jacket and his boots apparently were already made overseas. I think there is enough providers of underwear, socks and jackets from enough different countries that the fact that China takes a big share of remaining US textiles out of existence, shouldn’t be seen as a strategic threat to us. Furthermore we could probably pull a couple of textile producers back into manufacturing if we ever found ourselves ever …well for that matter we could have a ‘strategic underwear’ reserve like our ‘strategic petroleum’ reserve if we were really that anxious about something like that.

So getting back to the discussion about high technology work, I think China has more to be concerned about not being able to do cutting edge technology and development, than we have to be concerned about who has the machine tool shops necessary to take a high end design and extrude the plastic needed to put something together.

I would rather have my cards than theirs in this hand of poker any day.

And that was Dan Rosen Principal of China Strategic Advisory and Visiting Fellow at the Institute for International Economics and adjunct Professor at Columbia University.

I’m Maryann Keady and you’re listening to Asia 2025.

Now last week I interviewed Jose Belo about violence in East Timor, which I have written alot about in last year.

And a feature of my commentary, has been the role of US-Chinese competition in the country, and how the violence is just one example of this geo-political tussle. And the importance of sea lanes around Timor, in this battle.

Well an academic from Darwin Kate Reid Smith, had this to say last week.

‘ if China secured working control of East Timor’s sea lanes….the capacity to isolate Australia and Indonesia’s territorial and military assets could threaten China, and opens a regional Pandora’s Box.’

She also spoke of the inroads Beijing is making into Timor, and what this means for the tiny nation.

I spoke with Kate from Darwin, and began by asking her how China was creating a ‘satellite state’ in Timor….

Kate: I guess I’m basing that on China’s previous development and aid record, specifically from 1997 onwards, the Pacific, South Africa, you know, Gwadar and Pakistan, Cambodia, Myanmar. There is a certain trajectory that China appears to be pursuing and I believe that Timor Leste is just part of that future, that geo-strategic future that China is landscaping.

Asia2025: Right, but why East Timor? Why would East Timor be one place that it would be interested in?

Kate: I think geography has everything to do with it. Hydrocarbon rich Timor Leste does lie within maritime South East Asia. That tiny little former colonial backwater is completely swamped by vital maritime networks – global, regional – and really for China it makes perfect sense that it is at the southern tip of their back yard. They would want to be part of this untapped resource.

Asia2025: Well let’s talk about the resources later; I want to talk about the maritime sea lanes. Now I know the Ombei Wetar Straits are vital as are many of the sea lanes around East Timor. You’ve said it has the capacity, if China creates a foothold in East Timor, to isolate Australian and Indonesian territorial and military assets and open a regional Pandora’s Box.

Kate: Yes.

Asia2025: Can you explain that to me?

Kate: Well, I’m basing that on what’s happened in Myanmar and Cambodia again. As a strategic opportunity for China evolves, they could offer soft loans to Timor for Naval acquisition for example. It is a coastal state; China’s experienced in coastal operations. If China wants to protect its assets as it has done in the Sudan and in Africa, it will deploy troops to protect its assets. Now, given that Chinese regional aid packages are a component of dual technologies, I think that Timor Leste, because of it’s small size people ignore it, the international community ignores it basically, and I believe the equatorial proximity of Timor Leste is just an untapped resource that China can possibly and this is a theoretical, if it wants to expand it’s commercial communications and satellite business Timor Leste would be an exploitable, marketable commodity to lease space for profit for example.

And if China wanted to tap into lower cost battle scenarios and share cost effective methods such as war against terror and asymmetrical warfare, I think China would be looking at somewhere that it could build another small, but you know, hidden electronic infrastructure, kind of what’s on Hainan Island where space tracking and other electronic facilities, listening facilities that sort of thing could come to play.

The other side too is China’s pursuit of fisheries aid, and a lot of their maritime reach such as Fiji, Namibia – where it’s other satellite tracking station is, all start off with fisheries. They do a lot of development technologies close, inshore fishing that type of thing.

Asia2025: Well, there’s two aspects to this, they are building the foreign ministry and the Presidential Palace for whoever wins the April 9 election, but Australia donates its own money, and I mean, we have eight hundred Australian troops in East Timor, Australia does, we have New Zealand troops, Australia has United States bases in our north, surely East Timor is well within our sphere of influence. I’m not saying there couldn’t be a critical juncture where they meet, but surely Australia’s taking notice of this.

Kate: I think Australia’s taking notice, but I think it’s more so taking notice because Timor Leste is geographically within a vast Indonesian maritime expanse. And Indonesia remains of enduring strategic significance to Australia, so any disruption of sea routes, for example if China was to deploy as anti-piracy measures to protect their fishing assets or whatever might be happening in the region, I think the growing trend of anti-Australianism that is emerging from Timor Leste according to media reports might actually be playing to China’s regional hand given that China’s trying to pursue these vast maritime strategies, as in a blue water or a green water navy.

I don’t think Australia is ignoring what’s going on in Timor Leste, I just don’t think Australia’s looking at it significantly, and I think we’re taking far too much for granted that the status quo will remain the same. By that I mean that Indonesia and Australia will remain as the South East Asian regional maritime nexus but I think Timor Leste is a new player on the block that’s not actually being taken too seriously.

Asia2025: Let’s talk about what future scenarios. I have spent the last year in America and I know people there were concerned about the maritime build up of China. You say there’s a possibility that East Timor could be a staging post or could be an area of conflict in the future in the region, in between these interests of the United States and China?

Kate: I think so, because I think for many years Indonesia has relied on the maritime theory that those major maritime powers who had the most interest in keeping the sea lanes open, such as the United States, would continue to do so. However, with China coming in, that has to be factored as well because after the tsunami in 2004 we see where there were restrictions placed upon American MEU’s, Maritime Expeditionary Units, where before they could traverse, you know - criss cross fairly easily, India, Pakistan, Sri Lanka, Indonesia, all put restrictions on where the deployment of the United States and Australian maritime assets could actually be in regards to their EEZ’s and EFZ’s.

Asia2025: Can you just explain what they are?

Kate: EEZ is the Exclusive Economic Zone and ESZ is the Exclusive Fishing Zone, usually twelve nautical miles, and depending on where they are of course, but then again they’re pretty fluid and not all states adhere to them. Indeed if they’re not signatories to the United Nations Convention of the Law of the Sea then it really doesn’t matter anyway. But I think the issue that the maritime networks are out of direct line of sight of Jakarta and Canberra, and Washington to some extent, particularly the mineral areas that Timor Leste is crowned by as well which is all Indonesia, uranium, tin, gold - you name it, you know, and that stretches from the south of the Philippines to the West Papuan coastline where significant Chinese fishing interests have, in the recent past, have reportedly been in skirmishes with the Indonesian Navy, so it’s interesting to see that the skirmishes between fishing vessels under Chinese flags are increasing as well.

Asia2025: It seems that economics plays a large part in this, because China is desperate for resources, desperate for oil and gas, and so this is a significant part of its expansion of its needs really, as much as the military.

Kate: Yes, I agree, and given the issues with the Middle East, I think it’s logical that China will be looking for a myriad of global areas for alternate oil supply and gas supply. Timor Leste fits the bill nicely.

Asia2025: One piece of evidence that China seeks to influence Timor is that Petro China is funding a seismic study for oil and gas in East Timor. But isn’t it natural though that East Timor would clearly acquiesce to this, as a sovereign country, as a young country, surely you would want to go to someone who wants to, who’s going to pay the highest price? If you look at Australia, we’ve also welcomed Chinese investment in our country, in the North West shelf. So in one way, East Timor’s only doing what other countries are doing in the region.

Kate: I completely agree, bearing in mind that Timor too is the first new nation of the post cold war twenty first century, it’s not a product or a by-product of old cold war rivalries. There are no polarized alliances systems that it’s got to work its way through, if you know what I mean. It doesn’t have that inherited cold-war mentality and I think Timor Leste has been very prudent the way that it has actually dealt with, and encouraged and accepted China’s charm offensive, specifically with the hydro-carbon resources, because it’s both off-shore and on-shore that Petro China has been involved in deep water technologies, specifically looking for hydro carbon of course, aside from the Timor gap. So there is a vast range of other areas, and I know that it’s a very emotive issue when we keep talking about the Timor gap, but there are a vast amount of other areas within Timor Leste‘s maritime responsibilities such as off the coast of Oecussi they believe there is vast oil and carbon there, also along, just up towards Aturo Island there’s reports that there is other oil there.

There are, I guess because everything’s been focused on Timor gap there’s been a bit of an issue too, because that kind of detracts from looking elsewhere if you know what I mean? On Ombei Wetar Strait.

Asia2025: Well that’s the deepest submarine, that’s the deepest underwater trench isn’t it? And that’s very important as I understand it for the United States, and for any country……

Kate: Any conventional or nuclear submarine can transit that deep water passage without having to surface. It’s the only one in our regional maritime networks, and it’s the fourth most strategic important waterway after Malacca and Lombok Straits.

I remember Prime Minister Alkatiri, not long after Timor Leste gaining independence actually highlighted the fact that China – Petro China in particular, had been awarded the contract for off-shore exploration, off the coast of Oecussi which sits on the Ombei Wetar Straits.

Little facets of maritime technology that seem to be subdued in the wider emotive argument of the Timor Sea, I think it’s actually, I think the China/ Timor Leste relationship may already be a diplomatic moot point, and I think Indonesia and Australia are having trouble coming to terms with the fact that there are two new major players in our geo-strategic region, that being of course China and Timor Leste as an emerging player.

Not because of it’s size, but just because of its geography, because of where it is. It’s close to these strategic networks, like other areas in South East Asia such as the Philippines, when President Arroyo, when she withdrew her troops in support from Iraq to secure the release of that Pilipino truck driver the US decreased foreign aid by more than a quarter. Now Beijing stepped in and offered more aid to the beleaguered Arroyo, and within a few months there were the reciprocal visits all funded by China between the President, her Defense Ministers and their Chinese counterparts, and then following a protocol where China was given to explore for oil inside the Philippines Exclusive Economic Zone.

And this includes further Chinese millions of US dollars in military assistance, Chinese language training programs, engineering equipment what-have-you. And you see this is a complete turn around from 1995 when China actually militarily seized areas in the Philippines EEZ and established a People’s Liberation Army Navy presence.

So all these little things, I think, that Timor Leste has very cannily been taking on board because there’s no longer that cold-war rhetoric of, you know, playing off one against the other, the United States against Russia for example, to gain better aid. And I know that Kiribati is doing the same thing, playing off the issue of Taiwan against China, but China in 2002 is not the same China it was in 1980 – you know what I mean? And I think all these little tactics that Timor Leste have learned from the smaller nations.

Asia2025: However, I was talking to Dr Mahathir Bin Mohamad actually a couple of weeks ago, and I put to him, as I did to Sir Michael Somare, however that people are playing the United States and China off as far as I see it. That in fact everyone is playing the game and seeing what they can benefit. That said, at the moment, I would say that the United States is far ahead strategically than China since 2001 because of the moves, and the diplomatic moves it’s made back into Asia, correcting the balance that China had made previously. How would you view it?

Kate: I think it’s pretty much getting to the stage where there’s going to be an on par issue. I don’t mean open conflict between the United States and China, but certainly the tables have been turning for China in the region. And also the way China has been conducting international relations now bearing in mind that Timor Leste and China are members of the Community of Portuguese Language Countries or CPLP. Now that is a mutual friendship, a multilateral forum for those nations across the world where Portuguese is the official language. And China is a member of that exclusive club because of Macau. Now it supported of Macau’s succession to this community of Portuguese speaking countries, but it withdrew Hong Kong from the Commonwealth after reunification in 1997.

So there are these little hidden international relationships that China has throughout the region and Timor Leste being one of them as a Portuguese speaking country, and that they’ve been talking about other things such as mutual military cover operation and a multilateral deployable CPLP joint force, and I don’t think a lot of strategic think tanks in the United States, indeed in Australia, are actually looking at these other linkages that China is forging ahead with.

So, I take your point and I do agree that the United States has attempted in part to regain it’s own strategic footholds in South East Asia, but I think, at the end of the day, China is somehow a bit cannily, perhaps it’s a holistic view of things, usurping them in other areas, I mean after all, Timor Leste is another independent nation that can support China at the United Nations. So I don’t think the United States is that far ahead as it would like to be, but it is definitely ahead at this stage.


And that was Kate Reid Smith, from Charles Darwin University.

And that’s it for this week.

Thanks for listening.