John Wong, For The Straits Times

China's trump card in economic diplomacy


China has long used trade and economic ties to advance its foreign policy interests. But these days, it is learning how to do it better

In the two years since Mr Xi Jinping took over China's presidency as its supreme leader, he has managed to consolidate his power as China's real "strongman" after Deng Xiaoping.

Externally, Mr Xi has sought to pursue an active foreign policy to elevate China's international standing. The main thrust of his foreign policy is to cultivate "good-neighbourly relations" with countries on its periphery and closer political and economic ties with countries afar.

At the global level, China is promoting a "new type of major-country relationship" with the world's sole hegemon, the United States.

Recent months have seen a further rise in Beijing's trajectory. The pomp and ceremony that accompanied China's hosting of the 22nd Apec summit in Beijing in November last year left an unmistakable message to the world that China is a fast-rising power which deserves a "rightful" regional and global role.

Shortly before this meeting, the International Monetary Fund (IMF) confirmed that China would be the world's largest economy by the end of last year in terms of PPP (purchasing power parity) gross domestic product.

China's present levels of economic production, consumption, trade, capital movements and tourism have already made a huge impact on the global economy. With its vast foreign reserves of US$4 trillion (S$5.52 trillion), relatively low government debt, persistent "twin surplus" (in both current and capital accounts), and a healthy fiscal balance, the Chinese government has indeed been very "cash-rich".

Thus, Mr Xi at the Apec summit was able to put up China's own kind of "Marshall Plan" by setting up a US$40 billion fund to assist countries in his proposed Silk Road zones in infrastructure development.

This was soon followed by another initiative to establish the new Asia Infrastructure Investment Bank (AIIB), with China providing half of its US$50 billion start-up capital.

Economics has been at the forefront of Mr Xi's new diplomatic initiatives. For years, China has been pushing its central foreign policy message of "peaceful rise". But this has been met with some scepticism by its neighbours, given Beijing's sometimes too-assertive stance in handling bilateral territorial disputes and its lack of soft power.

The shift of focus to economic diplomacy is a natural one for China to take, to alleviate the weakness of its geostrategic approach.

To borrow from an economic term, China possesses a stronger comparative advantage in economic diplomacy than other options.

China thus hopes that its stronger geoeconomics can make up for its inherently weaker geopolitics.

China's history of economic diplomacy

"ECONOMIC diplomacy" is basically a strategy of using more "carrots" than "sticks". It has always been an integral part of a state's overall foreign policy pursuits.

At the height of mercantilism around the 16th century, some European states blatantly used economic diplomacy as both a means and an end. Thus, trade was to follow the flag; and colonisation was purely for the acquisition of bullion and raw materials.

In a globalised modern economy today, the economic instruments available for diplomatic uses have greatly increased, ranging from trade to economic aid and loans, foreign direct investment and technology transfer. Their application has also involved a much higher level of sophistication.

Historically, the Chinese practice of foreign policy was rooted in the Chinese concept of world order. This was not based on equality, but arranged in hierarchical order, with the Imperial court establishing tributary relations with the "barbarian states" on its periphery.

In managing such a China-centric regional order, Imperial China was, as noted by Henry Kissinger, "remarkably pragmatic about the means it employed", which included open coercion and outright bribery.

Harvard historian John K. Fairbank had also argued that tribute-bearing missions were themselves a convenient "cloak for trade". Suffice it to say that economic diplomacy was already widely used in Imperial China.

In Mao Zedong's China, politics and ideology took command.

Trade, sports and cultural exchange all had to be subservient to the state's overall foreign policy goals. Thus, when its relations with Malaya (Malaysia) turned sour in the 1960s, Beijing promptly switched its purchases of rubber from Kuala Lumpur to the more expensive but lower-quality variety from Ceylon (Sri Lanka).

In the 1980s, to reward Philippine President Ferdinand Marcos' initiative in normalising relations with China, Beijing supplied petroleum to Manila at "friendship prices" (well below world market price). China did likewise for Thailand.

The most controversial case of Mao's economic diplomacy was the building of the 1,860km-long Tanzania-Zambia Railway in the early 1970s at a cost of US$500 million to China, which was then truly "poor and blank".

The project yielded China little concrete political and commercial benefits except perhaps facilitating China's regaining its UN seat in 1971 with a few additional African votes. This project has since remained a negative example of China's excessive use of economic diplomacy with almost zero returns.

Deng started economic reforms in 1978. His overall foreign policy line was extremely pragmatic, and focused on trying to gain or regain its seat at various international organisations, first the World Bank and the IMF (1980), and eventually the World Trade Organisation (2001). China has been a major beneficiary of these international organisations and subsequently also one of their active participants.

Regional economic diplomacy

FOR regional economic diplomacy, China had learnt from post-war Japan. Much like Japan, lacking a voice and strong political and institutional influence in the region, China initially had to concentrate on expanding its markets and later the acquisition of the region's natural resources and raw materials.

In 2000, Premier Zhu Rongji proposed the China-Asean Free Trade Area (Cafta), the first largest "Asean Plus One" regional trade scheme. In 2010, the Cafta came into effect, with two-way trade reaching US$500 billion last year. China also put up the US$10 billion China-Asean investment fund to deepen economic cooperation with individual Asean countries. More recently, China is focusing on the larger, 16-member Regional Comprehensive Economic Partnership (RCEP), which is Asean-centric but mainly China-driven.

As its economy has grown and its external balances rapidly expanded, China is becoming an increasingly important capital-surplus economy.

Last year, its outbound direct investment (ODI) exceeded its inbound foreign direct investment (FDI). With its total ODI amounting to US$140 billion, China had become the world's third-largest source of FDI.

China has openly touted its strong financial and technological capability to develop infrastructure (for example, its high-speed rail) for emerging economies.

In recent years, China has also significantly expanded its Official Development Assistance (ODA) programme. During 2010-2012, it doled out a total of US$14 billion (largely grants and interest-free loans) to developing countries in Africa and the Asia-Pacific.

China's present ODA commitment is still small, compared with the traditional Organisation for Economic Cooperation and Development donors. But China has the potential to catch up, particularly since many OECD countries today have run into serious fiscal deficits. All in all, China is clearly in the thick of deploying all the major conventional economic diplomatic tools that Western powers and Japan have formerly used.

Steep learning curve

DESPITE its long traditions in economic diplomacy, China is admittedly still a novice in this game, especially when it comes to operating in the market environment or in a country with a more open political and social system.

On the one hand, China has gained considerable political mileage by featuring itself as a member of the South and a champion of the developing world, operating without such ideological conditionality as demanding commitment to liberal democracy or improvement of human rights; and displaying no territorial ambitions or seeking any military alliances.

On the other hand, China as an authoritarian state ruled by a communist party has also suffered many "image problems" as it conducts its economic diplomacy overseas.

China's investment acquisitions in developed countries have often been viewed with political suspicion or even blocked for "national security" reasons, for example, the case of Huawei telecom equipment manufacturer.

China's investments in Africa's mineral developments have also been accused of relentlessly exploiting its depletable natural resources. China's generous giving of aid and loans to certain developing countries "with no strings attached" was derogatively viewed as "buying friendship".

Beijing has recently recognised that some of its overseas economic ventures have not been financially productive. Spearheaded largely by state-owned enterprises (SOEs) and administered by bureaucrats or diplomats with no business or financial background, many of its overseas projects were often overpriced or short-changed, full of corruption and kickbacks.

Its generous soft loans to such financially stressed countries as Argentina, Venezuela and Russia are, as noted by the British magazine The Economist, just "a waste of national treasure".

Mr Xi has been trying to put things right. His anti-corruption campaign has cleaned up many SOEs, and netted numerous corrupt officials. This will certainly help raise the operational efficiency of China's future economic cooperation ventures overseas.

The US$40 billion Silk Road Fund is tipped to be run in a more businesslike manner, similar to what the World Bank's IFC (International Finance Corporation) has been doing. It is going to be more market-oriented.

China is learning that economic diplomacy, to be effective and viable in the long run, has to stick to certain essential market rules.

China will eventually learn that there are limitations to its economic diplomacy. No amount of economic carrots can buy off nationalism or core national interests in other countries. Also, economic diplomacy alone is not sufficient to create enough "soft power" for China.

The writer is a professorial fellow at the East Asian Institute, National University of Singapore.