Wednesday, April 22, 2009

Interview with Kazumasa Iwata today

This morning I interviewed Kazumasa Iwata, head of the Japanese Cabinet Office's Economic and Social Research Institute and former deputy governor of the Bank of Japan. Check out Policy Innovations soon for the audio and iTunes for the podcast. He was between meetings with government authorities and financial institutions, so the interview was a brief 16-minutes but nevertheless very rich in insights.

Apropos of Earth Day today and in response to my question about Tokyo's future role in Asia, he listed several environmental measures he saw desirable for Japan, including striving to build a low-carbon society, reducing emissions, replacing older, higher-emitting automobiles, and increasing research and development in clean energy technology--something that Japan has excelled in for decades (see a piece I co-wrote on Japan as an efficiency superpower here).

As for Japan's response to the financial crisis, he seemed worried about the employment situation and gave the impression that Japan's monetary policy and fiscal stimulus packages were meant to cork the loss of jobs but would not necessarily create new ones--as Japan appears to be creeping up to possibly a 6-8 percent unemployment rate.

What was the biggest issue Mr. Iwata saw for the US-Japan relationship for the long term? I was pleased that his answer was to fight protectionism. He sees a growing threat of trade protectionism through the use of WTO-legal measures. As I have advocated with Sherman Katz and Robert Fauver, Mr. Iwata even suggested that the US and Japan pursue a free trade agreement.

Friday, April 17, 2009

Alas, We Are Not All Keynesians Now

Policy Innovations contributor Susan Aaronson suggests that the G-20 can use trade and labor policy coherence to fight the global economic downturn, especially its effect on developing countries (Originally posted on VoxEU.org):

The most famous economist of the 20th century, John Maynard Keynes, had an evocative image of capitalism. He once said that markets were propelled by animal spirits. These spirits could yield growth, but at times they must be domesticated to ensure that the law of the jungle—eat or be eaten—does not apply. As markets run wild, policymakers must work at both the national and international levels.

Keynes was particularly concerned with how these animal spirits might affect workers. His views were colored by the massive unemployment he saw during the Great Depression. Keynes feared a "senseless international competition" for jobs. He wanted "new and better arrangements" to link trade and employment. These views influenced the international economic architecture.

After years of negotiation, policymakers agreed to new and better arrangements, as stated in the preamble of the General Agreement on Tariffs and Trade (GATT), which governed trade from 1948–1995, and its successor organization, the World Trade Organization (WTO). Both affirm the parties recognize "that their relations in the field of trade and economic endeavour should be conducted with a view to raising standards of living, ensuring full employment and a large and steadily growing volume of real income and effective demand."

Thus, the members of the GATT and WTO posited trade could create a virtuous circle: By regulating protectionism, trade would expand. Firms could achieve economic efficiencies—producing more goods and services at lower costs. More people would have jobs, access to new opportunities, and ultimately see improvements in economic welfare. By collaborating to regulate protection, the signatories could ensure that trade works for more workers.

However, as the world confronts the worst downturn since the Great Depression, the idea that expanded trade will create and maintain jobs is losing support. The World Bank has forecast that in 2009 global industrial production could decline by 15 percent and world trade may record its largest decline in 80 years. Policymakers have not yet devised effective multilateral responses. Most countries have adopted a wide range of domestic strategies including domestic stimuli; make-work programs; buy-local policies; and sector-specific subsidies. After examining these strategies, last month the WTO found "limited evidence" that its members were adopting trade-distorting measures.

However, while such strategies may not be protectionist in intent, they are not internationalist in their ends. Few policymakers appear to have considered how these strategies designed to restore domestic employment and growth might affect conditions abroad. Because they have eschewed collaboration, the fabric between global trade and national employment is increasingly frayed.

In 2008, for the first time, the WTO and the International Labor Organization partnered to examine the relationship between trade and national employment. The two organizations recommended that national policymakers find ways to make their trade and labor policies more coherent. They also suggested that policymakers could focus on their own citizens' employment needs and act to help developing countries job markets and policies. Many developing countries don't have the funds or capacity to provide such services. But the report suggested no incentives to make such strategies a reality.

So here is a suggestion. The world's largest economies (which include developed and industrialized countries) met in London. These members of the G-20 should consider a two-pronged approach to expanding trade and increasing employment. As evidence of their commitment to multilateralism, these countries should go beyond their pretty words about the Doha Round and commit funds to help developing countries build a social safety net for their workers, and establish programs for lifetime learning.

Along with this incentive, these countries should agree to (and ask other WTO nations) to adopt a "no standards lowering clause." With such a clause, members agree that they will not attempt to attract or maintain investment by lowering labor (or other standards) in the interest of maintaining jobs. Such a clause is consistent with a key objective of the WTO: to increase market access. Governments can distort market access when they change the rules governing markets. 1

In addition, the WTO should disclose (on a public website) which countries are adopting trade-distorting policies, discuss the specific policies these countries have adopted, and encourage scholars to examine how these policies might affect national and international employment. Such transparency can also play an important role in making global markets more efficient and more equitable. 2

Some have argued that, because so many governments have adopted Keynesian solutions to the downturn, "We are all Keynesians now." But we are not truly Keynesian unless we are willing to find global strategies that expand trade and stimulate employment at home and abroad.

Susan Ariel Aaronson is Research Associate Professor and 2009 Policy Research Scholar at the George Washington University.

1. Kyle Bagwell; Petros C. Mavroidis and Robert W. Staiger, "It's a question of market access," American Journal of International Law, 96, No. 1 (Jan. 2002), 56–76.

2. Susan Ariel Aaronson and Jamie M. Zimmerman, Trade Imbalance: The Struggle to Weigh Human Rights in Trade Policymaking (Cambridge: 2007), Conclusion, 186–207.

Wednesday, April 15, 2009

REINING IN THE WORLD OF FINANCE

At last week's Workshop for Ethics in Business on Restoring Trust in the Global Financial System a certain consensus emerged: the trust lost in the recent financial crisis can only be restored through the introduction of a fair, transparent, and most of all international regulatory regime.

There was, however, another consensus reached by the panelists, Neal Flieger, Stephen Jordan, Seamus McMahon, Christian Menegatti, Tom Donaldson - that while the goal of creating a new system of financial governance is noble, it is also unattainable. The blame-game and a competitive scramble to re-capitalize and re-regulate the financial sector is in full swing. Continental Europeans blame the Anglo-Saxon model for the recent crisis, Russia and China are calling for a new reserve currency (a concept also articulated in a recent Policy Innovations article by Korkut Erturk), and the US Financial Accounting Standards Board just changed unilaterally the way banks value their assets - and thus their losses. The spirit of cooperation is nowhere to be seen.

A comment by Stephen Jordan helped me to put it all in perspective. He called the structure of the financial system pre-Lehman collapse a giant poker game, with none of the participants knowing what the others were holding in their hands. This was also a major argument put forward by Neal Flieger, who proposed that the current crisis, and the Obama administration's response to it, has been an "opportunity to be transparent and honest." One can assume this means the present system is anything but. We are thus provided with an explanation for why, according to Seamus McMahon, trust levels in the banking sector and the stock market are below 20%.

Why, then are we not seeing the development of a consensus on a universal regulatory regime? Tom Donaldson identified three causes of the current crisis: (1) a pattern of paying for peril, (2) a normalization of danger, and (3) the tech shock that created financial instruments too complex to understand or regulate. As the world emerges from this economic disruption, and financial institutions begin to rebuild their balance sheets, should we expect a return to the behaviors of the past?

The discussion of a global oversight body, the rebuilding of trust, and multilateral agreement on restraining the most egregious behavior, brought to mind another upcoming round of talks, those on a successor to the START treaties. Nuclear disarmament talks gained momentum during the Regan administration - a president not known for being soft on the Soviet Union. What drove Regan then was the repugnant nature of the nuclear weapon, along with the realization that the arms race, at least in the nuclear sphere, got out of control.

And here the parallels between the current financial crisis and the nuclear disarmament talks crystallize. Just as we continue to live with the specter of mutually assured destruction, we have gotten a taste of what can happen when the financial markets implode and take the global economy with them. Little wonder Warren Buffet called some instruments "financial weapons of mass destruction." The arms race, or the recent regulatory race, created the untenable situation of governments compromising on safety for the sake of building a more potent arsenal (of warheads or international financial institutions). Both situations also resemble the classic prisoner's dilemma - the only way out is for all parties to trust each other and coordinate their actions.

The agreements entered into by the Soviet Union and the US required both to cede some degree of sovereignty. Both countries agreed to restrain their weapons build-up. Both also agreed on an inspection regime more intrusive than anything seen before. This "trust and verify" approach, as President Regan dubbed it, became the foundation for all future US-USSR treaties. It can also form a solid foundation for a new international financial markets regulatory framework.

That the US will need to restrain its financial sector is also the theme of Martin Wolf's column in today's Financial Times. Aligning that restraint with others, however, has so far only been advocated by the likes of Merkel and Sarkozy. It was the Europeans who have advocated for a convergence of regulation, and placed it on the agenda at the G20 summit in London. Nevertheless, we may not be too far off from the day when this idea takes root in the US as well. After all, if Washington is willing to compromise on such a sensitive issue as defense policy, what is to stop it from ceding a bit of sovereignty and allowing a body like the IMF to scrutinize its financial regulation? We already know the costs of inaction.

Thursday, April 2, 2009

South Centre Statement on the Impact of Economic Crisis on Developing Countries

South Centre Executive Director Martin Khor made the following statement (3/25) to a special UN General Assembly dialogue on the world financial and economic crisis and its impact on development:

1. The extraordinarily serious global economic crisis has its origins in the developed countries. Developing countries are not responsible, but they are severely affected, and in ways that are worse than the developed countries, as they also lack the means to counter the effects.

2. Developing countries are only in the past few months beginning to feel the effects of the crisis, due to the lag time in transmission. The crisis will certainly last longer than originally expected, and then it may take even more time before a full recovery.

3. There is thus growing anxiety in the developing world. When he met the British Prime Minister Mr. Gordon Brown, last week, as part of the preparation for the G20 Summit, the Ethiopian Prime Minister Mr. Meles Zenawi warned that African countries could face political chaos if the recession hits at full force. In developed countries such as Britain, the worst problem being faced in the downturn was unemployment. But in Africa, the recession means that "people who were getting some food would cease to get it and instead of being unemployed they would die", said Mr. Zenawi, as quoted in the Financial Times.

4. The developing countries are being hit through two transmission levels—trade and finance. The first transmission channel is through trade. There has been a sudden and steep fall in manufacturing exports, the fall being 30 to 50 percent in many Asian countries. Then there is the fall in demand, prices and export earnings for commodities, affecting especially low-income commodity-dependent countries. On 17 March, The Economist's commodity-price dollar index for all items had fallen by 40 percent compared to a year ago (with declines of 29 percent for food, 44 percent for non-food agriculture products and 56 percent for metals). Earnings from services are also falling, for example in tourism (in the Caribbean tourist arrivals are expected to fall by one third this season) and migrant workers' remittances (a 6 percent drop is estimated by the World Bank for 2009).

5. The second transmission channel is through finance. There is a rapid decline of bank loans to developing countries, whose companies may find it difficult to roll the many hundreds of billions of dollars of foreign loans due this year. There is a reversal of portfolio investment into developing countries, from large inflows in recent years to a sudden huge exit. Net capital flows to emerging markets fell from $929 billion in 2007 to $466 billion in 2008 and will fall further to $165 billion in 2009, according to the estimates by Institute of International Finance. Even FDI is rapidly slowing down because of difficulties in access to credit and economic contraction. If the past record is a guide, aid flows can also be seriously affected in the near future. Trade financing has also been affected by risk aversion, and is choking trade flows; a shortfall of $25 billion in trade financing was reported at a recent WTO meeting.

6. These trade and financial shocks are leading to stresses on the overall balance of payments, with a fall in foreign reserves, and a depreciation of the local currency in some countries. All these together threaten developing countries' ability to service their external debt and avoid a debt default situation. There are already 10 countries that have had to go to the IMF for emergency loans and many other countries are likely to be lining up in the near future.

7. All of the above are causing a stress on the real economy, with declines in GNP and industrial output, a reversal in poverty eradication and a slowdown in social development, as governments face reduced revenues and budgetary stress. Most developing countries are constrained from taking the fiscal expansion measures similar to those of developed countries.

8. There is a need for developing countries to examine the options for national policy on each aspect of the economic crisis and to seek the appropriate policies. However, only some policy measures can be taken at national level, especially if the country is too small to rely on the boosting of domestic-led growth. Regional-level measures are important. And most critical are the reforms, actions and cooperative measures required at the international level.

9. The South Centre views the two issues of reform international actions needed to counter the recession from the perspective of the problems and interests of the developing countries. What are the priority issues for the developing countries, on which action is urgently required?

10. Among the priorities for the South are (1) establishing an international system that fosters financial stability for developing countries; (2) having access to adequate and stable financial resources, as private flows and exports decline; (3) avoidance of financial and debt crises and proper management of crises if they occur; (4) unimpaired access to markets for goods and services; (5) avoiding collateral damage from policies taken by developed countries in response to the crisis; (6) formulating policies for the short and long term for recovery and development, and being able to maintain and expand policy space to implement these policies.

11. There is need to review and reform the international financial and economic systems to ensure the problems that led to the crisis are not repeated and that the international system does not prevent but positively encourages developing countries to have the adequate policy space to deal with the crisis nationally.

12. There are dangers that some crisis measures taken by developed countries may have adverse effects on the South, and thus a need to prevent or offset these actions. For example, developed countries' agriculture subsidies used to be the main distortion in world trade but these are now accompanied by huge subsidies to financial institutions and emerging subsidies to manufacturing (the auto industry). Developing countries lack funds to match these subsidies; they should be allowed to take measures to prevent subsidized service providers like banks and subsidized goods from overwhelming their domestic markets. In the area of tariffs, developing countries should be allowed to exercise their right to use the policy space to raise their applied tariff if it is below the bound tariff. A moratorium against raising applied tariffs would be imbalanced because there is little difference between the applied and bound rates in developed countries, unlike the developing countries.

13. Private investors and public agencies in some developing countries invested in or lent to private and public institutions in developed countries. Developed countries' governments should assure that the assets of developing countries are protected. Pressures from interest groups that exclude developing countries' assets or loans from bailout plans (for example, the suggestion that AIG should only honor claims from nationally owned institutions) should be resisted.

14. New forms of trade protection that affect developing countries should not be introduced. The fiscal stimulus programs should not exclude goods and services from developing countries, as has happened with the Buy American clause in the recent US stimulus package. Developed countries are mainly exempted from the clause due to their membership of the WTO plurilateral procurement agreement, of which most developing countries are not members. There is also need to guard against a new trade protectionist element being proposed in the climate policies and legislation of some developed countries; if this is introduced, it could have a further adverse effect on developing countries' exports and add more stress in this crisis period.

15. A high priority for developing countries is to establish international measures to foster financial stability and avoid activities driven by speculation. The crisis originated from banking deregulation and excessive liquidity creation, causing speculation to be rife in capital and currency markets. Developing countries have been hit by these speculative activities leading to violent fluctuations in capital flows. But because of highly costly self-insurance taken in large stock of reserves, these swings have not created the kind of dislocations seen in 1997 in Asia. An important part of the solution is to reinstall firewalls and regulations to avoid speculative capital flows unrelated to real economic activities (trade and investment) and to establish a system of currency exchange where currency rates reflect underlying fundamentals. This should be a major priority in the reform of the international financial architecture.

16. In the absence of reform and an international system regulating these flows, developing countries must have the policy space and be allowed to undertake national policy measures to regulate capital flows and to defend themselves from speculation. However the required policy space to take the required measures is hindered by (1) IMF-World Bank conditionality that mandates an open capital account; (2) Many North-South free trade agreements that (a) mandate the free and unregulated inflow and outflow of funds; (b) liberalization of financial services, including the entry of foreign institutions for "new financial instruments;" (c) liberalization and deregulation of investments. These barriers (the loan conditionality and the FTA provisions) to the required regulation should be reviewed. Existing FTAs should be reviewed to consider amending clauses that prevent the required regulation. Current negotiations on FTAs such as the EPAs between the EU and the African and Pacific countries should fully take this into account.

17. A major plank of the new financial architecture is the reform of the IMF. Its policy conditionalities have previously not been appropriate in assisting developing countries deal with crises. These include: (1) the policy of an open capital account system, that deregulates capital flows (increasing financial vulnerability) and discourages or prevents capital controls over inflows and outflows; (2) pro-cyclical monetary and fiscal policies that have magnified contractionary conditions; (3) trade policy linked to extreme liberalization of imports and industrial policy based on non-state intervention, which have damaged domestic agriculture and industry in many developing countries. A preliminary review of recent crisis loans to 10 countries (including some developing countries) by the IMF show that contractionary financial and fiscal policies (such as a significant increase in interest rates, and a reduction of government spending) are still maintained as part of the loan conditions.

18. A reform of the IMF is thus crucial. Without the reform, it is premature to expand its resources. The IMF should not impose or promote an open capital account or prevent regulation of capital flows. It should not deal with trade and industrial policies and other development-related policies. The reform process should lead to its creditor role being confined to providing short-term loans to countries to deal with temporary balance of payments difficulties. In that area, its policies should be counter-cyclical and not pro-cyclical. Countries should not be requested to provide loans to the IMF to augment its resources because this would compromise the ability of the IMF to carry out its surveillance function and to discipline the policies of countries that provide the loans. It can obtain resources from the market or from the issuance of SDRs, instead of obtaining loans from governments. The imbalances in the system of governance, with its present serious imbalance in voting rights and decision-making, should also be addressed.

19. One major source of financial instability is that the international reserve currency is the currency of a single country (the United States). This causes instability as availability of reserves for the world economy depends on the reserve currency country (the US) having growing current account deficits. This problem is worsened under the present crisis because of: (a) the absence of multilateral discipline over exchange rate and macroeconomic policies of the US; (b) developing countries' increased vulnerability to fluctuations in capital flows and exchange rates; (c) pro-cyclical behavior of financial markets; (d) developing countries holding large stocks of foreign reserves at very high costs. As an alternative, an international reserves system based on the SDRs could be established. The IMF could distribute SDRs to itself to make it available to members, and there should be greater automaticity in access to it.

20. The new financial architecture should include establishment of a multilateral fund or funds. This could be similar to the two oil facilities set up in the 1970s to assist countries cope with the oil price increases and to prevent a global recession. The fund can assist developing countries counter the recession and to offset the multiple losses of financing caused by reduced exports, migrant remittances, service payments, loans, investments, trade financing, etc. The shortfall facing developing countries may total many hundreds of billions of dollars a year. The fund should thus be of a major amount. The channels of funding and its multiple uses should be determined together by the international community.

21. Developing countries should also be encouraged to explore and expand regional financial cooperation. Examples of this are the Chiang Mai Initiative and its extension in Asia, and the Bank of the South in Latin America.

22. The new financial architecture should also deal with the threat of new debt crises facing developing countries. The current account and overall balance of payments of many developing countries and their foreign reserves are or will be coming under increasing stress, due to a crisis that was not of their doing. The reform process should establish as a priority an international system of debt standstill and debt workout for countries that face debt servicing difficulties. Proposals on this (which originated at UNCTAD) had been rather extensively discussed, including at the IMF, but did not lead to any conclusions. Given the present crisis, this should again be a priority proposal. A new round of debt elimination and debt relief should also be looked at now.

23. For many of the poorer countries, dependence on commodities has revived as a serious problem because the positive conditions and high prices of the past several years have vanished. The stabilization of commodity prices and fair remuneration to producing countries has thus become a priority crisis issue for developing countries. International cooperation on resolving commodity issues should thus be on the reform agenda.

24. The crisis provides an opportunity to address the deficits and imbalances in the governance of global finance and economic issues. The United Nations used to play a central role in policy formulation and in reaching and implementing agreements. However in recent years, too much faith and power had been given instead to the markets and to international financial institutions which supported the drive towards "marketization" and "financialization." At the national level, in developed countries in the centre of the storm, the pendulum has swung, with the leadership and interventionist role of the state being emphasized. The international counterpart of this national-level development should be the strengthening of the role of the United Nations, including its General Assembly and its economic arms, particularly ECOSOC. Greater authority provided to a strengthened and more effective UN should be a crucial element of the new global economic architecture.

25. The UN General Assembly high-level conference in June is an important opportunity for discussion and follow-up actions on the wide range of issues of the crisis and how it affects development, and the remedies required. The South Centre is willing to contribute to the success of this very important event.

Notes from Skoll World Forum

Policy Innovations friend and contributor Carol Holding recently attended the Skoll World Forum and shared some of her notes with us. She looks at the event from a brand and CSR strategy perspective:

The annual gathering at Said Business School, Oxford University, attracted 800+ social enterprise participants in social, academic, finance, corporate, and policy sectors from over sixty countries. It was perhaps the only celebration of capitalism in a country hit by "anti-capitalist warriors" protesting the G20 meetings. As Jeff Skoll, founder of the Skoll Centre noted, the mood was as effervescent as you would expect from a group of "people with a purpose who know their time has come."

Skoll, an American, was the first president of eBay and now chairs Participant Media, the film company that produced An Inconvenient Truth and Syriana. The forum was bookended by speeches from film company leaders, with an opening plenary that included Kenneth Brecher, Executive Director of the Sundance Institute, and a closing plenary with Lord Puttnam, producer of Chariots of Fire, The Killing Fields, and Midnight Express, who now focuses on education and the environment. These speakers engaged the passion of attendees while promoting the ability of video to build awareness and engage people in addressing social ills. But where was the link to building effective business organizations?

A panel on storytelling offered an explanation that should appeal to my branding colleagues: Both are opportunities for intervention. Getting people to be empathetic is the key to activation, as one filmmaker put it, to move them to consider "What would I do?" Marrying that moral imperative to a product could become increasingly important in a world where, as one delegate commented, marketing is the new fossil fuel.

Participants–To my surprise, many wore suits and some ties and had a sophisticated financial orientation, just like traditional entrepreneurs. Sessions were built around subjects like financial models, accountability and measurement, strategies for scaling and business tools such as the talk on branding. A senior editor from Fast Company bemoaned the formal dress but loved the excitement of the conference and wished the topic of social enterprise were given a special section in his magazine. No publication currently owns the space and he sees an opportunity for Fast Company.

This pro-market environment was reinforced by luxe lecture rooms in the modern Said Business School and the Oxford locations used in the evening. Dinner was held in various Oxford College dining halls—I was assigned to Keble, a truly Hogwartsian setting—and the following evening's reception was in the Examination Schools, also steeped in conservative tradition. Evening plenaries were held in the Sheldonian, a magnificent 17th century building where Oxford's honorary degrees are presented.

Sustainability was defined more broadly than the environment, and all environmental entrepreneurs had products with a social justice benefit as well. Three of the nine Skoll Awards went to organizations that had an environmental product or service. For example, I met founders of companies that produced wind turbines and solar panels, both offering low-cost or easy-to-operate products, but distributed in less developed markets.

Academia–There was a fair degree of focus on academia as Social Entrepreneurship struggles to become an accepted discipline within business schools. I spoke to faculty and deans from schools like INSEAD, Cambridge, Vanderbilt, and NYU who likened the field's awkward "adolescent-like" status to Entrepreneurship twenty-five years ago, before there were enough studies conducted and papers published to validate the field. Even the definitions are not set, and sister fields such as Social Enterprise and Social Innovation confuse and dilute the meaning of Social Entrepreneurship.

Wednesday, April 1, 2009

Reverse China Hedge

For the past five years or so, the common wisdom in Washington was that the best way to deal with China's uncertain future was for U.S. policymakers to employ a "hedging strategy" toward Beijing. The logic was elegant: Warriors at the Pentagon should dissuade China from acting aggressively while diplomats in Foggy Bottom should persuade China to act responsibly and peacefully.

This hedging approach was clearly articulated in 2006 in President Bush's National Security Strategy, saying it would "encourage China to make the right strategic decisions for its people while we hedge against other possibilities." Earlier that year, the Pentagon's Quadrennial Defense Review Report similarly spelled out that while it would focus on "encouraging China to play a constructive, peaceful role in the Asia-Pacific region” it would also aim to create "prudent hedges against the possibility that cooperative approaches by themselves may fail to preclude future con´Čéict."

While the United States has been trying to create more policy coherence and be more consultative in its posture toward the world, China has been displaying some elements of a hedging strategy against what some might see as an uncertain future for U.S. power. Several factors might explain China's more multifaceted approach toward the United States, including domestic demand for an external scapegoat for economic woes, uncertainty about how the financial crisis will play out, and an overall more intertwined relationship between China and the world.

When Chinese asked me five years ago whether China was a friend or a challenge to the United States, I would say both. I called this seemingly dissonant approach toward China the result of a complex democratic process of policy making. Similarly, as China's middle class grows and its social stability becomes more worrisome, its own posture is becoming less monolithic.

This is one of the main findings from a trip to China I took last week with China scholar Josh Eisenman. The trip, which was a follow up to a delegation we led last September to Beijing, took us to four Chinese cities (Beijing, Qingdao, Nanjing, and Shanghai) and one farming village in Shandong. In my view, our conversations revealed more ambivalence about China's approach to the United States. As some have said, China may "seize" perceived U.S. weakness to reconfigure its position in the global pecking order. There was no question that China benefited from good relations with the United States and everyone preferred a healthy U.S. economy. But the doubt over U.S. economic health relative to Chinese economic growth has opened the door to a deeper debate.

On one hand, China benefits from the U.S. security, markets, and financial arrangements. On the other, however, China is naturally, almost mechanically, reconsidering its place as it grows.

This theme emerged during a long conversation we had with a senior Chinese scholar. It went something like this:

"Does China feel that the United States is a threat?"

"No."

"So why does China feel the need to expand its power projection and build its military?"

"It is in response to U.S. military power."

In other words, China may not feel that the United States is a threat per se, but the very fact that the United States is powerful is driving China to grow its power and act more like a "great nation." It is like international relations balance of power theory is a natural law.

My message to our Chinese hosts was simple: If China would like to act more assertively in the South China Sea, for example, it needs to provide global public goods as well. As it stands, China's opaque and increasingly powerful military is starting to scare its neighbors. The international system is predicated on safe sea-lanes that are guaranteed by the U.S. navy; the safe sea-lanes facilitate open trade and foster global peace and prosperity. If China wishes to challenge this arrangement, it will have to offer something.

Another area in which this theme has turned up is in the U.S-China economic relationship. Just before we left for our trip to China, Prime Minister Wen Jiabao said he was worried about his dollar assets. "We have lent a huge amount of money to the US. Of course we are concerned about the safety of our assets. To be honest, I am definitely a little worried," he said. His statement masked China's dilemma: It needs the United States to stimulate its economy with loser fiscal and monetary policies, which could drive down the value of the dollar, hurting China's dollar assets. Complicating the relationship, a weaker dollar could also lead to a lower volume of Chinese exports to the United States at least in the long run.

Fortunately, this week at the G20 meeting in London, Presidents Hu Jintao and Barack Obama found common ground on shared interests of stabilizing the global economy, cooperating in addressing climate change, and creating a high-level strategic and economic U.S.-China dialogue, which could help build trust between these two powerful nations. Out of a common sense of fairness, there seems to be agreement that the governance of the IMF must be restructured as well. The China hedge may be reversing but so far longer-term, strategic interests have prevailed.

Photo of Tiananmen Square taken by the author during the trip.