September 2013

Japan Center for International Exchange

China and Shared Regional Prosperity:
Five Risk Factors
Hitoshi Tanaka, Senior Fellow, JCIE

Finding the right approach to China is perhaps
the biggest task for Japan and other countries in Asia
Pacific. The sheer scale of China’s rise leaves no doubt
about its importance to shared regional stability andprosperity. At the same time, while stories of China’s
burgeoning economy abound, so do concerns regarding risks with the potential to derail its growth story.
In particular, China faces five key risk factors that
could turn those concerns into reality. These domestic and external risk factors are highly intertwined. Assuch, when engaging China we must pay close attention to how its domestic risks shape its external policy.

Short-Term Domestic Instability
An important pillar of the Chinese Communist Party’s(CCP) political legitimacy lies in its ability to continue
to foster economic growth and improve living standards. While China has enjoyed unprecedented economic growth rates over the past three decades, thedays of 10 percent growth appear to be over. In the faceof widespread bad loans, questionable shadow banking practices, and rapidly growing income inequality,

Chinese Premier Li Keqiang has been talking about
retreating from economic stimulus policies and about
deleveraging the financial sector and implementing
structural reform in order to shift to a more sustainable pattern of development. Forecasters now predict
China’s growth rate will settle at around 7 percent.
Simultaneously, China’s new leaders must also deal
with widespread corruption and environmental challenges, including food safety and air pollution, whichhave been a source of deep frustration for many people. Overall, China’s current situation requires a finebalancing act between managing people’s expectations for a good life now and the need to implement
structural reforms to prevent future crises, as well as
knowing how quickly and how far vested interests canbe toppled without catapulting the system into a hardlanding or worse.
Moreover, Chinese citizens are increasing populist pressures on the government by expressing theirpolitical frustrations online. As such there is the riskthat President Xi Jinping will be tempted to use diversionary tactics, such as leftist mass movements

and an emphasis on nationalism vis-à-vis external hostile forces (including Japan and the UnitedStates), to distract the people from the CCP’s governance shortcomings.

of academic freedom, means that China risks notcreating the human capital necessary to deal with
future challenges.

“Core Interests”
Long-Term Domestic Structural Challenges

China is in the habit of using the term “core interests”
to refer to issues that it deems important enough to go
to war over. Issues that the CCP has defined as core interests include disputes regarding Taiwan, Tibet, andXinjiang and in recent years have at times been broadened to also include issues regarding the Senkaku
Islands and territories in the South China Sea, as wellas the border conflict with India. Regarding Taiwan,
the current situation appears relatively calm, as theKuomintang government under President Ma Yingjeou has emphasized improved economic ties withthe mainland through such measures as the 2010
Economic Cooperation Framework Agreement. Still,there is no room for complacency and the situation
has the potential to change quickly. In Tibet andXinjiang, the fact that separatist groups are facing off
against the CCP’s assimilationist policies means that
there is an ever-present risk for riots to spark.
Applying the “core interest” label positions an issue as crucial to the CCP’s pledge to protect China
from repeating its past “national humiliation” at thehands of foreign powers and as such constrains theCCP’s policy options. It is therefore crucial that othercountries in the region be aware of tripwires that mayforce the CCP into a corner where it must take anexcessively tough stance for the sake of its politicallegitimacy. At the same time, the region must workwith China to encourage it to transcend its current
domestic political dynamic within which nationalism exerts tremendous pressure on policy concerning
what China considers to be its core interests.

China faces several long-term structural challenges
that could affect its economic and political stability.
For example, given the expected growth in China’s
middle class and Internet penetration rates, the newly
prosperous and educated are likely to have greater
expectations of the government and a greater capacity to exert pressure. Thus, for the sake of long-term
internal stability, the CCP must proactively explore
ways to give citizens legitimate channels to vent political frustrations rather than having them resort tounauthorized protests or making anonymous posts
on Weibo, the Chinese version of Twitter. In addition,
reforming the hukou household registration system—
which restricts citizens of rural domiciles from sharing in the economic benefits accrued by the richer
coastal areas—is crucial to addressing rising income
inequality. However, for it to be successful it must be
implemented in tandem with improved rural migrant
access to employment, housing, social welfare, andeducation.
China also faces looming demographic challenges
that are worsened by the fact that it will be the first
country to get old before it gets rich. Repealing theone-child policy will help mitigate this, but potential
gains are limited due to the lag in real changes to thepopulation structure and the reality that many parents may still make the choice, for economic reasons,to have only one child. Hollowing out is also a risk
to China’s growth given that the rising cost of labor
is leading companies to relocate factories outside of
China to countries with cheaper wages. Moreover,corruption and political problems are prompting
China’s rich to emigrate in increasing numbers.
China will need to break through the middle-income
trap by moving up the production chain while also
staving off a brain drain. Finally, the CCP’s control ofthe education system, which is characterized by theinstitutionalization of patriotic education and a lack
EAST ASIA INSIGHTS

US-China Relations
The US-China relationship is of utmost importanceto the region. Relations between the two countries appear to be heading in a relatively positive direction,although considerable frustration remains within
the US Congress due to the lack of concrete results.
President Obama and President Xi’s recent California
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September 2013

Japan-China Relations

summit and the Strategic and Economic Dialoguethat took place a month later saw the two countries
discuss practical cooperation on issues such as theKorean Peninsula, cyber security, and a possible bilateral investment treaty. However, if not managed carefully, these issues could potentially become spoilersand undo the good work.
China has begun framing its relationship with theUnited States as “great power relations.” Xi appears
to be promoting this conception of relations with theUnited States to the people of China as a new typeof great power relations, or as trans-Pacific cooperation, in tandem with his call for a “Chinese dream”
and “national rejuvenation.” The United States, however, is reluctant to go along with such lofty rhetoric,
which may lead to an implicit acceptance of China’s
conception of its core interests, and instead appears
intent on adopting a pragmatic approach to cooperation focusing on concrete areas. So this positioning ofrelations can be seen as a double-edged sword. On theone hand, if referring to great power relations helps tosatisfy Chinese nationalists at home and leads China
to become a responsible regional stakeholder, it is apositive outcome. On the other hand, if such nationalistic politicking leads China to adopt an aggressive
posture, pursue hegemonic actions, use force to settle
disputes, and shun international norms, regional stability will be greatly undermined.
Coordinating North Korea policy is also a pricklyissue. China is seen as a key influence on the North
Korean regime. While Obama and Xi agreed inCalifornia that North Korea cannot be recognized asa nuclear power, and South Korean President Park
Geun-hye’s trip to Beijing has seen a renewed improvement in ROK-China relations, questions remain
regarding how far China is willing and able to pressure North Korea to commit to meaningful negotiations and ultimately to denuclearization. The extent towhich a coordinated US-ROK-Japan-China approach
toward North Korea is possible will be one measure of
US-China relations and the potential for substantive
big power cooperation.

EAST ASIA INSIGHTS

Japan-China relations have deteriorated to new postwar lows. In particular, the Senkaku Islands issue has
put great stress on the bilateral relationship and undermined cooperation. Under the current circumstances, Japan-China relations can be seen as the mostimmediate risk factor with the potential to seriously
jeopardize regional stability. From the Japanese standpoint, there appears to be no room for a compromiseon the Senkakus given the clear historical records. At
the same time, given the high level of nationalism thathas been associated with the issue in China, the CCP
will aim to avoid any impression of a compromise. As
such, the only rational move under the current circumstances is an attempt to reduce tensions. With noimmediate resolution in sight, Prime Minister Abeand President Xi need to sit down together and findthe right plan to manage the issue so that it is not allowed to dominate the relationship and undermine
substantive areas of cooperation. The decision by Abe
to not visit Yasukuni Shrine on August 15—the day
Japan commemorates the end of World War II—will
hopefully help create an opening for positive relations
between the two leaders.
The Japan-China relationship is critical to bothcountries as well as to the region given the two countries’ huge trade and investment flows, their economic complementarity, the interdependent natureof regional production networks, and their respective political influences. Moreover, as Abe seeks topush through the much needed third arrow of hisAbenomics program—structural reform—to revitalize Japan’s economy, and as Xi seeks to balance China’s
economic deceleration as part of the shift to a moresustainable pattern of development that still responds
to public expectations of continuing improvements
in living standards, neither leader can afford to allow
disputes to undermine economic cooperation. A resetis needed immediately.
To this end, a strong political commitment isneeded from both countries, including the espousalof a future vision for the relationship. Public relations measures to improve citizens’ understanding of
the bilateral relationship beyond the Senkaku issue
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September 2013

and the removal of barriers to increased people-topeople exchanges are also needed. Moreover, themomentum generated by Japan’s joining the TransPacific Partnership should be utilized to accelerate
negotiations of trade pacts that both Japan and China
are party to, namely the Regional Comprehensive
Economic Partnership and the Japan-China-ROK
FTA. Finally, the region stands to accrue tremendous
gains by launching intensive regional energy cooperation, especially through the East Asia Summit,and Japan-China cooperation in this area is key toits success.

it to better address its domestic risks. On the otherhand, if the CCP is not attentive enough to its domestic risks, it will increasingly feel the need to resort todiversionary tactics that malign the United States andJapan, further exacerbating its external risks. It is also
important for Japan and other countries in the region
to take into account all of these five risk factors, including China’s domestic challenges, in formulating
successful approaches to China. The manner in which
China faces up to these risks—and the cooperation
the region gives China in this process—will havelong-lasting effects on the future of regional stability.
If the region can get this tricky mix right it will cement shared prosperity for decades to come.

◆ ◆ ◆The intertwined nature of these five risk factors meansthat they cannot be addressed in isolation of one another. If the CCP focuses solely on its domestic situation and merely reacts to external events as they
unfold, it risks losing the opportunity to reap the benefits of economic cooperation that would in turn help

Hitoshi Tanaka is a senior fellow at JCIE and chairmanof the Institute for International Strategy at the Japan
Research Institute, Ltd. He previously served as Japan’s
deputy minister for foreign affairs.

East Asia Insights
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September 2013