South China Sea: Learning from Cold War Episodes

South China Sea was one of the more prominent flashpoints in 2012 and is likely to remain one as we start 2013. As I pored over news reports of new military exercises, deployment of troops and military hardwares (all of which are driven in one way or another by the US) to countries in the region, I can’t help but to compare this episode to those that happened during the Cold War era.

When Castro took control of Cuba and purchased crude oils from Soviet Union for processing, the reluctance of US oil companies based in Cuba to process the oils had the unintended effect of pushing Castro more towards Soviet Union and the eventual Cuban missile crisis. Similarly, Johnson’s operation rolling thunder and policies towards the peasants in then South Vietnam pushed them further towards the embrace of Communist North instead of convincing them of the ideals of freedom and democracy.

In both episodes, US’ hawkish stances had the unexpected effect of pushing these countries closer towards their rival instead of bringing them to the negotiation tables, where the probability of outcomes more favorable to the US would have been conceived. In our current South China Sea issue, China appears to have adopted similar hawkish attitude as the US did for the above episodes. I am not entirely sure if China realizes that if this behaviour is to continue, history may repeat itself; in other words, China will end up pushing their neighbours closer to the US and concurrently, give more boosts for Obama’s pivot to Asia.

In China’s interest, the sensible thing will be to tone down the rhetoric and find a middle ground to solve the issue. China had accumulated lots of neighbourly goodwill in the past and it is certainly not worth it to throw them away over a single episode.

Improving Workers' Condition: From Another Perspective

The plight of factory workers, notably in China has captured the attention of many people across the world. Sights of squalid living quarters, seemingly unending working hours and absence of basic welfare in these factory towns resulted in rightful calls for better treatment for the most important people in the production lines.

In a rush to support this just cause, we appear to have forgotten one thing and unknowingly have committed a mistake, that is, of asking the workers what they really want in their working life but instead enforcing our definition of what’s best on them.

A TED presentation by Leslie T. Chang gave support to this view. In a series of interviews with workers whom she had established relationships with, Chang found out that while workers probably appreciate improvements in issues raised as examples above, they actually gain higher utility (in the words of an economist) from things/activities that may result in potentially better jobs. Some of these include the opportunity to learn computer skills and English.

As we close 2012 and embrace 2013, I thought this is a good reminder to everyone who has the good intentions of helping someone: never assume but in the words of Ernesto Sirolli (another TED presenter), shut up and listen before we come up with ways to help someone.

Happy New Year Eve!

Economic Slowdown and Nationalistic Behaviour

Two weeks ago, I mentioned that the Chinese economy is still very much reliant on demand from the West and alluded that it was not really domestic consumption boost or successful diversification, but rather false expectations about the speedy recovery in EU and US that had contributed to the outside appearance that Asia, particularly China has successfully decoupled itself from the West sometime ago when Asia seemed to be doing pretty well as opposed to EU and US (More on Decoupling and Asia).

The latest data released on the Chinese economic slowdown and the need to clear existing inventories served to prove this point. Indeed, an article by Damian Grammaticas from BBC gave some examples of industries where the number of days to clear inventories have increased exponentially.

In that pervious post, I made a passing (and cautious) remark that the Chinese government can consider learning a thing or two from Indonesia, which has been able to drive economic growth by boosting domestic consumption. Learning from Indonesia is one thing. Question is: has the government ever considered boosting domestic consumption as an option to pick up the slack from EU and US? Judging from its past actions, it certainly has. However, boosting domestic consumption is not a free lunch. While they largely fulfill their objectives, interest rate cut and the likes also lead to inflation, default, etc, things that the government has been trying to put a lid on.

Even if they have certain mechanisms in mind to counteract these unwanted side-effects, they may want to tone it down and give the limelight for solving the economic slowdown to the new generation of leaders that are expected to take over the country later this year.

So when you want to do something that will impact your population but can’t really do it for economic and political reasons, the simplest way is to divert the attention of the population away from it. Perhaps this is the reason why China has become more nationalists with regards to South China Sea and other nearby waters in the past few months.

Decentralization in China: Lessons from Gu Kailai

Gu Kailai, wife of Bo Xilai, a former rising star of the Chinese Communist Party, was sentenced to death with a two-year delay last Monday. After the announcement, the focus of the media was on how it was a foregone conclusion and speculations arose about when Bo himself will be charged and if so, what his likely sentence will be.

What’s interesting to me is that no one actually bothered to analyze something that is very much the norm in most countries but is different in China, especially when it comes to court cases; that is the location where Gu was charged. Generally, the accused is charged by the court in the jurisdiction where the alleged crime took place. But here, we have someone who allegedly committed the crime in Chongqing, but charged by the court in Hefei, Anhui, which is a totally different city and province altogether. Why is this so?

When I read the book entitled “The Party” by Richard McGregor, I found that this action has precedent in the case of Chen Liangyu, the former Party Secretary of Shanghai who was charged in 2008. Chen was charged in Changchun, Jilin, also a totally different city and province from the alleged crime. The explanation given in the book was that Changchun was far away from Shanghai and that Shanghai judges could not be trusted to follow Beijing’s order. If this is indeed true, then Beijing has valid reasons for assigning the court in Hefei to charge Gu.

However, I have not brought up this observation simply to explain Beijing’s decision. Rather, what I want to say is that decentralization in China has reached a level where the perception that Beijing still has a strong grip on whatever that is going on in the country is no longer true. The system has been structured in such a way that the highest position in a specific region has a say in almost everything that goes on that he/she is effectively the “ruler” of that fiefdom, up to the point that it is beyond the control of Beijing. Isn’t it ironic for a Government who likes to portray that it has everything under control?

More on Asia and Decoupling

About a year ago, when US and Europe were down, Asia had rebounded and many people were saying that it was a sign Asia had successfully decoupled itself, I cautioned against such a view in a post “Have We Arrived?”

Just about a month ago, China reported that its growth has slumped to a three-year low of 7.6 percent in the second quarter and one main reason was the continuing bad news coming out from Europe amid a slow US recovery. If my argument then was not convincing enough, surely the arrival of these statistics would add substance to it now. It is however not the intention of this post to do just that. Rather, I would like to speculate on why the data a year ago would have misled many people into thinking that Asia had decoupled from the West when it didn’t.

Central to my speculation is the concept of expectations. Few people in China would have expected the crisis in US and Europe to drag for so long considering all the actions taken by the respective governments. They had continued to produce and stockpile their products ready to be exported when the West demanded them. This act of production and stockpiling could have contributed to the rebound observed a year ago. Obviously, this expected demand never materialized. Since the existing stock had not been cleared, there was no need for new production and hence the observed current slowdown.

If domestic consumption had increased substantially over the same period, it would have cleared at least some of the existing stock but this was not the case. Apparently, domestic consumption either remained stagnant or did not increase sufficiently to replace the demand from the West. In fact, if manufacturers were to factor in expected increase in domestic consumption into their production decision a year ago, their existing uncleared stock would have been even higher than if they did not do so. In other words, both the expected increase in demand from the West plus domestic consumption that never materialized has resulted in the current slowdown.

Right about now, people who disagree with this speculation would say that it depends on which part of Asia you are looking at and would point to an Asian country further south of China to make their point: Indonesia. Growth of domestic consumption in Indonesia has been phenomenal, an excellent example of one way a country could decouple itself from the West. Perhaps, China could learn a thing or two from Indonesia about boosting domestic consumption. Is it?

Well, I would again warn against jumping straight to an unsubstantiated conclusion. Indonesia tomorrow could be China today. Indonesia as part of Factory Asia is a supplier of parts and components to China, the final assembler. The current increase in domestic consumption could have been driven by expectations that China will continue to demand parts and components, which is highly unlikely if recent statistics can serve as reliable indicators of how things will evolve.

Drainage Oil From Another Perspective

The case of drainage oil from China maybe old news for some readers but it is a new one for me, having heard about it from a friend last week. I think that it is a case worth mentioning if we are to consider that China’s food industry continues to draw flaks. However, I would like to end this post with some thought-provoking statements.

For those of you who need a refresher or have never heard about this case, drainage oil is a term used to describe used cooking oil that is poured into the drainage. Rumor has it that some oil recyclers literally collect them from the drainage, process and then sell them back as recycled cooking oil.

According to the media, this is a serious problem in China but is it really true? Could it just have been a case that is blown out of proportion in light of the negative publicity surrounding China’s food industry? If this idea of recycling cooking oil from the drainage has been carried out in the developed countries, would it have been viewed negatively? Would it instead have been singled out as an innovative technique?

Will ASEAN Lose Out From The Trilateral FTA Between China, Japan and Korea?

Sometime ago, China, Japan and Korea finally agreed to kick-start talks that would lead to a Free Trade Agreement (FTA) between them. This move brings about two contrasting views. For the optimists, it shows that the 3 countries are finally ready to put behind their historical enmity in the name of economic growth. For the pessimists, particularly those that believe in ASEAN centrality, it is the beginning of the end of ASEAN’s role in providing neutral ground for the 3 countries to negotiate and engage one another, especially if bilateral communications on some matters are close to impossible.

On the economic front, the pessimists fear that the expanded market size of this FTA would reduce ASEAN’s competitiveness when it comes into being. I would like to argue the opposite. China is such a huge market that it does not really need to add Japan and Korea’s population to its investment attraction strategies in order to attract more investments. In other words, firms that find China as a prospective investment location would not have waited until now before making their moves. They would have done so long time ago. There is certainly a value for Japan and Korea use the expanded market size to attract more investments but given the high labor costs in both countries, I doubt expanded market size is a strong pull factor by itself.

Then, there are those who said that ASEAN may be left out of the East Asian fortress since the FTA does not involve them. But this is an unlikely event since ASEAN has arguably pre-empt this by having FTA with each of them. I will also argue that the regional production networks that have been developed and nurtured over the years is not something that can be altered overnight, more so if there is no basis to do so at all.

Last but not least, the talk is only about to start and most definitely has not yielded anything tangible. For all the commotion, it may end up being another FTA that is trade-light and more driven by politics rather than economics.

Rising Inequality = Social Unrest?

Rising inequality is often attributed to the many social unrests that China has to tackle recently. But is this the only reason for the spike of social unrests?

Could the increase simply be due to a more open government that is willing to share news of ongoing unrests? Or rather, due to more areas in China being more accessible to foreign journalists?

Could it also be due to people that are more aware of their rights as citizens? Or simply as an act to reject the current norms of interactions between the government and its people?

Unipolar or bipolar?

My father once told me that when the world was bipolar, Indonesia had one of the strongest military in the southern hemisphere. Then, I could not understand why that was the case because I was born and spend my entire life in a unipolar world. Recent events however have made me understand things better.

To put it quite simply, you cannot play one power against another in a unipolar world but can do so in a bipolar world. When one does not want to provide you with assistance, you always have the alternative option of engaging the other. The lack of military assistance provided to the East Timorese by the Australian has led them to request for assistance from China. In a unipolar world, there will be no gunboats and army barracks for the East Timorese. Additionally, in light of the delay in the funding promised by several developed nations to the Libyan Transitional National Council, one wonders if the ongoing visit by Mustafa Abdel-Jalil to China has got anything to do with this.

Whether the desired wishes of countries are good or bad remain open to debate. What is clear is that these wishes are more likely to be fulfilled in a bipolar world.

China’s migrant workers: In search of prosperity or is it?

In search of better lives for themselves and their families, many people who live in rural China become migrant workers and work in large cities. While the practice of rural-urban migration is common across countries, the presence of traditional registration system that is still operating in China meant that it is not possible for the children of these workers to follow their parents to the cities because they will not be able to have access to services such as education and healthcare. As such, families break up and the children are usually taken care by the elderly in the villages.

At first glance, this seems to be a perfect arrangement. After all, it is unlikely that one’s parents will ill-treat one’s children. With this in mind, migrant workers move to the cities with the sole objective of earning enough money that they hope will get their families out of the cycle of poverty.

But is this true? Perhaps not. While money is important, it is not the only ingredient to get out of the cycle. In the words of an economist, money is a necessary but not a sufficient condition. While money can grease your way out, you need to have the capabilities and the right qualifications to be able to obtain jobs that can get out of your subsistence condition.

When migrant workers leave their children, they inadvertently take parents’ care away from their children and this is not really wise to do when children are in the stage of growing up. This may then affect them psychologically and start to have collateral effect on their education for example. With no good qualifications, the entire cycle seems likely to repeat itself for the next generation.

China's Role in Fighting Piracy

Due to its business model, piracy is like an infectious disease that can never be eradicated. Whenever companies implement new mechanisms to prevent piracy, it will not be long before someone comes up with a way to overcome them. Governments from around the world have also been doing their part in fighting piracy but to no avail. Does this mean we have no other options but to give up our fight?

Well, not really. Although the pirates are always able to stay one step ahead of us, this does not that the fight is over. There are still many things that we can explore to reduce if not stop piracy. And when it comes to government action, I believe no government can have a greater impact on the pirates than the Chinese government.

There are several reasons for me to make this statement. Firstly, the sheer size of China’s population means that the firm actions taken by the Chinese government on piracy can effectively starve the pirates of 1.2 billion customers. Skeptics may say that a large percentage of China’s population is still living below the poverty line and therefore should not be considered as potential customers. I don’t agree with this argument because here, we are talking about goods whose prices are so cheap that it is affordable even to the poorest segment of the Chinese society.

Secondly, piracy in China has evolved to such an extent that it gives the downloader of music/movies the impression that what he/she is doing is perfectly legal. By this, I mean that you can easily find and download music/movies from well-known websites. The excellent interface even allows one to sample the music first before downloading, to look for lyrics and even create a playlist of their favorite songs. Frankly speaking, I do not think there are many legal music/movies providers with such impressive and user-friendly interface.

Thirdly, China’s rising political and economic clout means that the number of people learning Chinese language is increasing rapidly. Consequently, the number of people that are capable of finding and accessing those pirated contents will also rise.

It is ironic and probably beyond the dreams of many artists, actors, actresses and directors that they have to depend on the Chinese for their very survival one day.

Can China Accept the Effects of Increasing Usage of RMB Globally?

I read an article in the Economist today which says that the Chinese government has a desire to increase use of its currency for international trade and finance. I must say I am really amazed by this desire because it simply means that the government must loosen its monetary policies, particularly those with regard to foreign exchange. For a long, long time, the government has kept a tight control on its monetary policies to promote export and for fear that foreign agents might manipulate the value of RMB. It isn’t easy to bring a large amount of RMB out of China and until a few years ago, it wasn’t even possible to exchange RMB to another currency freely in China.

With the about turn, it seems that the Chinese government has changed its mindset because increasing usage of a currency globally will without doubt mean that the particular currency must be revalued (something that the Chinese government has been dragging all the while because of its negative impact on export) and will be more susceptible to external manipulation (essentially losing absolute control of its currency). The Chinese government must be very confident that its huge reserves will be able to counteract any ill intent towards the RMB.

China's Miraculous Economy

I have always been wondering about the great accuracy of China’s prediction of its economic growth. While there are often differences between the predicted and actual economic growth made by various countries, China has always been spot-on. If the Chinese Government says that economic growth for the next quarter is predicted to be 10 % for example, it is guaranteed that the actual economic growth will be 10% if not more.

I find this phenomenon intriguing because numerous factors such as consumption, investment, government expenditure and net exports contribute to the measure of economic growth. No matter how capable a Government is, it is near impossible to control the actual numbers that reflect these factors because it is the behavior of the individuals that ultimately churn out those numbers. Unless we live in a machinistic society, it is highly costly and hence ineffective to monitor every single person to ensure that he/she fully abide by the rules that have been set by the Government.

I finally obtained my answer when I read an article in The Business Times titled “China’s growth – economic or accounting miracle?” In the article, the writer shared that Dr John Makin, a visiting scholar in the American Enterprise Institute had written in another article that China’s economic statistics are based on recorded production activity rather than expenditure growth which is made up of the factors I mentioned above. This means that things such as disbursal of funds and shipments to retailers rather than funds actually being used and actual sales by retailers to ultimate consumers respectively are recorded as GDP growth.

With such accounting methods, it is not a wonder or a miracle that China always achieves the target that it has set.

The Interesting Relationships between China, Taiwan and Dalai Lama

For as long as I can remember, China has always strike hard on countries or unclassified entities that appear to show support to those it labeled as enemies of the state. Actions taken by the Chinese Government range from those categorized as the norms in the diplomatic world to those branded as young kids throwing tantrums. Regardless of the actions chosen by the Chinese, we must say that they do strike sufficient fear on the would-be recipients that they usually back down from their initial stance. And such reactions are expected to become more pronounced considering China’s rising political and economic clout.

Occasionally though, there will be those who try to show that they are not under the Chinese thumbs. President Nikolas Sarkozy of France is one such man. He decided to proceed with his arranged dialogue session with Dalai Lama despite knowing full well the potential repercussions by the Chinese in response to his actions.

If you think of Sarkozy as a brave man, you will definitely agree with me that President Ma Yingjeou of Republic of China (the official name of Taiwan) is an even braver man. Unlike France, which is obviously not considered as a breakaway province by Communist China, Taiwan is and the successful visit by Dalai Lama to Taiwan could be clearly regarded as an embarrassment to the Chinese Government because it would send a signal that if the Chinese can’t even control what it regards as domestic affairs, how can it request to be given more say in international affairs.

One would expect a very strong response from the Chinese but so far, response has been surprisingly mild. Besides making some statements to show its displeasure to the visit, there have not been massive military exercises. There have not been clawback or annulment of agreements made by the 2 sides. The main reason, I am guessing, is China’s hesitance to take away the punch bowl in the midst of the party. Since his election, President Ma has made good his promise to build better relationships with Mainland China. A handful of agreements have been signed. Numerous more are in progress. Throwing tantrums will only mean falling into the trap set up by the opposition DPP, giving them the opportunity to badmouth the KMT and hence, prolonging the timeline for eventual reunification, a case of shooting its own legs.

In addition, the relevant parties have also been mature enough not to politicize the visit. President Ma and senior government officials have mentioned that they will not be meeting the Dalai Lama during his visit. The Dalai Lama himself has said clearly that his purpose for coming to Taiwan is to pray and give support to victims of Typhoon Morakot. He has also cancelled the press conference that he is supposed to participate in. It seems that the China-Taiwan relationship has indeed reached a higher level, thought impossible in not too distant past.

Boosting China’s Domestic Consumption: Tax cuts or government spending?

Since the onset of the current downturn, there have been constant mentions of the need to boost domestic consumption to compensate for the drop in world consumption, particularly so for countries that are heavily reliant on exports to drive their economy. It is a good suggestion although I have to qualify that any country considering it must meet one obvious prerequisite: a large domestic market.

With its population size of 1.3 billion people, the Chinese leaders can confidently proclaim that China meets this prerequisite without any difficulty. The next step? Urge its population to spend x yuan more than their initial intended consumption (x being the drop in the world’s demand for Chinese goods) and voila, the economy is still clocking its double-digit growth. Is it that simple? Unfortunately, not really.

China’s dependency on exports consequently means large proportion of its population is employed by both local and foreign companies that cater to international demand. A slump in international demand means fewer revenues or even losses to these companies and hence, cost-cutting measures such as retrenchments which inadvertently lower the spending power of the population.

To cut a long story short, there is a positive correlation between world’s demand for Chinese goods and spending power of the Chinese population. When the world’s economy shrinks, so does the pocket of the Chinese man walking down the street. And that is excluding the fact that Chinese are savers by nature, even when times are good. Great speeches without government intervention, it appears, will unlikely create the desired effect. Do the Chinese leaders have any plans on hand?

As a matter of fact, they have 2 options and they seem to be exploring both, though I am not sure if comparing their level of contributions to domestic consumption is part of the plan. Firstly, announcing tax cuts which essentially put more money in the pockets of the people in addition to reducing the total price of certain goods. Secondly, increasing government spending whose multiplier effect may also spur more spending by the people. To me, it is more of a question of trust. The first option means trusting its people to spend and the second option means otherwise.

At the moment, both seem to have some impact. China sees record car sales in March, exceeding that of US for third month in a row due to taxes on purchases of small cars being halved. As for notable government spending, China announces that it is pumping 850 billion yuan over 3 years to reform its health care system which includes giving each village a clinic.

However, which of the 2 options will make greater contribution to domestic consumption remains to be seen. My money is on government spending because when government spends, it really spends but tax cuts may end up in savings accounts or hidden biscuit tins. But then again, it maybe because I am a Chinese infused with Confucius teachings.

Pragmatism vs. Ideology: China’s SDR Proposal

Since Deng Xiaoping embarked on the policy of economic reform and openness in 1978, China has steadily been gaining prominence as a rising world power. Newspapers start allocating more spaces to articles on China. Television channels begin airing more shows on China, with topics as diverse as history and politics to foods and travels. The media blitz covering Beijing Olympics, billed as coming-of-age party last year further gave China the opportunity to showcase its remarkable transformation to the world. Gone are the days when it is an embarrassment to associate one with China.

The latest financial crisis also appears to be a blessing in disguise for the Chinese leaders. One by one, they denounced the deregulations of the financial industry by the Western capitalists which have been blamed as the root cause of the current downturn. They extolled their highly regulated system of government. Zhou Xiaochuan, Governor of China’s Central Bank, even went as far as proposing that US dollars be replaced by SDR as the new reserve currency. (SDR is accounting unit defined in terms of a basket of major currencies and is used primarily by IMF.)

As many countries, US included, begin to propose more measures to better control the financial industry, it seems that China is finally winning the war of ideology. But is the proposal to replace US dollars with SDR purely ideological? Is China sending a message that the role of US as sole superpower has ended? Well, not really according to Paul Krugman and I couldn’t agree more. Here’s his take in my own words plus additional comments.

To ensure that exchange rate remains fixed and hence its competitiveness as the world’s factory, China has been buying US dollars to counteract the increasing demand for Chinese yuan. The end result: lots and lots of US dollars in its reserves. If the US dollars weaken, there will be huge unrealized capital loss on the Chinese side.

Anticipating that such a scenario may happen in the future, in particular when the currently sidelined talks on yuan revaluation regain its momentum, China is looking at ways to minimize its impact. Replacing those US dollars with other currencies by itself is not an option because it is not possible to sell immense amount of dollars in the free market without triggering the value of dollars to drop and hence the much dreaded capital loss as well as the loss of its leading position as a premier manufacturing location.

Replacing those dollars by worldwide consensus, on the other hand, is a different story altogether. Because the transition from US dollars to SDR will be heavily regulated and closely monitored, it is unlikely to cause a sharp drop in the value of dollars, allowing the Chinese to more or less preserve their capital.

At first sight, the proposal gave the impression that China is flexing its muscle in the long-drawn ideological warfare. In reality, it is nothing more than the thinking of pragmatic leaders.