Even before the 9/11 terrorist attacks on the United States, the People's Republic of Chinawas shifting its strategy with respect to its neighboring countries and Washington away fromconfrontation and strategic competition toward economic cooperation and a reduction of strategicaggressiveness. Following several crisis points in China's international relations -- including the1989 Tiananmen Square repression, the 1995 seizure by China of Mischief Reef in the SpratlyIslands, the 1995-96 live fire missile exercises in the Taiwan Strait, the 1997-98 allegations ofChinese espionage, the 1999 NATO bombing of the Chinese embassy in Belgrade, and the 2001 U.S.EP-3/Chinese fighter aircraft collision incident -- Chinese relations with its northeast Asianneighbors and with the United States have now become fairly calm and constructive. Why China has turned its focus toward its own "peaceful development" rather than blatantlyasserting what it considers to be its territorial rights and periodically "poking fingers in the eyes ofits neighbors" is a complex question that will be addressed partly below. It seems clear, however,that Beijing has recognized that its attempts to assert sovereignty over disputed islands or the testfiring of missiles near Taiwan have proven to be counterproductive. Recent conflicts in Iraq andAfghanistan, moreover, have demonstrated anew that the United States is the premier global powerand that the U.S. military holds a large technological lead in the conduct of war. Beijing sees a hugecost to an open conflict with the United States. In the post 9/11 environment, moreover, Beijing hasbeen able to position itself in a way that puts it on the side of Washington in the global antiterrorismcampaign -- despite Beijing's concerns over the growing American military presence near thewestern border of China in Central Asia. Beijing's leaders also recognize that the legitimacy of theirmonopoly on government rests primarily on their ability to deliver a rising standard of living to theirpeople. This not only requires continued economic growth but stability in the region and undisturbedflows of capital and goods between China and the rest of the world. The economic rise of China has generated a reorientation of international trade patterns inNortheast Asia. For Japan, South Korea, and Taiwan, China has surpassed the United States as theirnumber one trading partner. As shown in Figure 1 , in 1995, South Korea exported more than twiceas much to the United States as it did to China ($24 billion vs. $10 billion). By 2004, South Koreawas exporting $50 billion to China but $46 billion to the United States. (2) Japan still exports more tothe United States than to China, but the trend is moving toward China. In 1995, Japan exported overthree times more to the United States than to China ($123 billion vs $29 billion), but by 2004,exports to the American market had risen to $130 billion while those to China had risen to $74billion. With Taiwan, the story is similar. In 1995, Taiwan (3) exported twice as much to theU.S. market as it did to the PRC ($29 billion vs $15 billion). By 2004, Taiwan was exporting $35billion to the United States and $34 billion to China. (Unlike Japan when it was industrializing,China is a major importer.) Figure 1. Exports by South Korea, Japan, and Taiwan to China and theUnited States, 1995 and 2004 ($billion) The situation with respect to China's exports to South Korea, Japan, and Taiwan is similar. As shown in Figure 2 , China's exports to Japan more than tripled between 1995 and 2004 and at $94billion now exceed the $54 billion in U.S. exports to Japan. The United States still exports more toTaiwan ($22 billion) than does the PRC, but China's exports there have quintupled to $17 billion in2004 from $3 billion in 1995. Likewise, China's exports to South Korea have quadrupled since 1995and at $29 billion exceed those from the United States ($26 billion) -- barely up from the $25 billionin 1995. The pattern of exports from China and the United States to South Korea, Japan, and Taiwanreplicate the import trends -- China is rising while the United States is static as a source of supplyfor these markets. Figure 2. PRC and U.S. Exports to South Korea, Japan, and Taiwan 1995 and 2004 ($billion) These shifts in trade flows away from the United States indicate that dependencyrelationships also are turning toward China. Not only are Japan, Taiwan, and South Korea becomingmore dependent on China, but China also is becoming more dependent on these economies forimports and exports. Many of the imports into China, moreover, are intermediate products andcapital goods that are vital to China's industrial sector and economic growth and enable China toexport to the U.S. and other markets. Exports to China, moreover, are important sources ofaggregate demand for countries such as Japan -- a nation that has been in and out of recession since1992. Another indicator of the shifting positions of the United States and China can be seen inforeign direct investment -- FDI or long-term investment in controlling shares of companies. Thisis investment in companies that provide goods and services in which the foreign investor controls10% or more of the shares. Looking first at the aggregate flows from all sources, Figure 3 indicatesthat while the United States is still the preferred destination for foreign direct investment, the trendis turning toward China. In 2003, China received $54 billion in FDI while the United States received$30 billion. Both the United States and China swamp Japan, South Korea, and Taiwan asdestinations for FDI. The United States, however, is also a major provider of FDI. In 2003,Americans invested $152 billion abroad while China invested $2 billion in FDI. In addition, sincethe United States has long been a favored destination for foreign investors, its cumulative stock ofinward FDI as of 2003 was three times that of China ($1,554 billion vs $501 billion). These aggregate FDI inflows into China play a geopolitical role in that they raise the cost ofinstability both within the PRC and between the PRC and its neighbors, particularly Taiwan. Moreimportant than the total inflows from the world, however, are the flows to China from itsneighboring economies. Of the $53.5 billion realized foreign direct investment in 2003, $5.1 billioncame from Japan, $4.5 billion from South Korea, and $3.4 billion from Taiwan. China's largestinvestor, however, was Hong Kong with $17.7 billion (some of this was actually Chinese moneywhich "round tripped" in order to take advantage of incentives that favor foreign investments). TheU.S. total of $4.2 billion was slightly less than South Korea's $4.5 billion but more than Taiwan's$3.4 billion. The general trend of foreign direct investment within northeast Asia has been for it toincrease or remain at a fairly substantial level. The United States is maintaining its rate of directinvestment in China, but that level is just on a par with that of South Korea. Figure 3. Foreign Direct Investment Inflows into the United States, China, Japan, South Korea, and Taiwan, 1995, 2000-03 For Japan, China accounted for $3.1 billion or 8.6% of its total $36.1 billion in direct foreigninvestment in 2003. Japan still invests more than three times as much in the U.S. market ($10.6billion in 2003) as it does in China, but the trend is striking. Between 1999 and 2003, Japan's foreigndirect investment in the United States dropped by 52%, while its FDI in China rose by 314%. (4) Other types of foreign investment are less significant in China than in countries with moredeveloped capital markets. In 2003, foreigners put a total of $2.64 billion in non-FDI investmentsin China (data are not available by country). This included $0.27 million in non-controlling shares,$0.13 million in leasing, $0.01 million in compensation trade, and $2.23 million in processing andassembly. (5) In bank borrowing, as of June 2005, China had a total of $98.6 billion (up from $78.5 billionin June 2004) loans outstanding from various sources. Of these, Japanese banks accounted for $17.4billion -- the largest source except for European banks who had $45.2 billion in claims on China. U.S. banks had $11.2 billion in loans to China (up from $6.9 billion in June 2005). Other largenortheast Asian borrowers from Japan include South Korea with $17.0 billion and Taiwan with $5.7billion. (6) In northeast Asia, therefore, a network of economic interdependence is developing in whichChina, Japan, South Korea, and Taiwan have strong vested interests in the smooth and continuousoperation of the system. Economic integration there is not as extensive as that in the EuropeanUnion or under the North American Free Trade Area (NAFTA), but it is developing rapidly. Notonly are these economies trading more extensively with each other, but their production processesare becoming vertically integrated. China acts as the manufacturing platform while neighboringcountries provide investment capital, finance, technology, management skills, and expertise. Figure 4. Percent of China's Exports and Imports Accounted for byForeign Funded Enterprises in China, 1988-2003 Perhaps more important than the amounts of trade flows and foreign direct investment andloans flowing into China are the economic ramifications of that investment. Currently, more thanhalf of China's exports and imports originate from foreign affiliated enterprises located in itseconomy. In 2003, as shown in Figure 4 above, 55% of China's exports and 56% of its imports wereaccounted for by foreign funded enterprises. Among provinces and metropolitan areas, Guangdong,Jiangsu, Shanghai, and Fujian were particularly significant. All these are coastal areas with a largeforeign presence. China's level of technology also has benefitted greatly from foreign investment and importsof machinery and equipment. Although recent data are not available, China's global market shareof high-technology products (aerospace, pharma-ceuticals, computers and office machinery,communication equipment, and scientific instruments) has risen from less than 1% in 1980 to 8.7%in 2001 (see Figure 5 ). This was considerably less than the 32% for the United States, but exceededthat of Germany or South Korea. (7) Figure 5. Global High Technology Market Shares 1980-2001 Meanwhile, China is using the allure of its rapidly developing economy and trade relationsto create a regional economic sphere revolving around China and with industries vertically integratedacross countries. The major first thrust has been with the Association of South East AsianNations (8) (ASEAN). China and ASEAN agreed in 2002 to negotiate an ASEAN-China free trade agreement (ASEAN +1) to be implemented between China and the six industrialized ASEAN countries by 2010 and therest by 2015. ASEAN also is considering the possibility of expanding this to an East Asia FreeTrade Area (EAFTA or ASEAN + 3) that also would include Japan and South Korea. (9) Japan and South Korea alsoare discussing a free trade agreement between them, (10) and Taiwan has sought closer ties with Japan and South Korea. Taiwan is clearly concerned over what it calls the bandwagon effect -- countries in the region"jumping on the bandwagon" to cement trade ties with China. East Asian countries also are joining forces to protect their currencies and avoid a repeat ofthe 1997-99 Asian financial crisis. In May 2000, finance ministers from ASEAN plus China, Japan,and South Korea established the first regional financing arrangement in East Asia. Called the ChiangMai Initiative, this consists of bilateral currency swap arrangements -- mainly from Japan, China,and South Korea to other participating nations -- during financial crises. (11) Another regional financialarrangement is the Asia Bond Fund. Announced on June 2, 2003, the fund began with $1 billion incontributions from 11 central banks from the more developed countries of ASEAN plus Japan,China, South Korea, and Australia. Seven additional contributing countries (including India) havejoined the fund. The fund is to invest in sovereign and quasi-sovereign bonds issued by Asiangovernments in international markets. Initially restricted to investments by central banks, in thesecond phase, the fund is to be opened to private investors (such as insurance companies and pensionfunds). The intention is to create greater liquidity, less reliance on dollar-denominated financialassets, deeper regional capital markets, and more stability in the Asian financial markets. (12) These financialarrangements are evidence of nascent cooperation and institution building among East Asian nations -- with both Japan and China playing major roles. Within China, moreover, economic success is affecting decision making and policies in theranks of the Chinese Communist Party (CCP). The CCP is including more of China's business andother interests both in its membership and policies. An estimated 30% of China's entrepreneurs(several million) are now members of the CCP. (13) These entrepreneurs are not poor peasants; many are the businesselite. In addition, numerous party members have, themselves, become involved in businesses orhave strong business interests. China may still be a one-party state, but that one party is graduallyrecognizing that it must reflect the interests of the people -- including those with business andeconomic interests -- if it intends to remain in power. (14) A further effect of the rapid development of China's economy is its growing appetite for rawmaterials and energy and other accouterments of modern life. In the market for petroleum, forexample, China's demand already has reached 6.7 million barrels per day, and in 2020 is expectedto climb to 12.0 million barrels per day or about 11 percent of world consumption. (15) Similar increases areoccurring in Chinese demand for steel, gold, natural gas, and other commodities. This is pushingup world prices for these items. One note of caution is that several negative factors are rising in China that could push thecountry into economic chaos or recession. While economic projections by econometric forecastingfirms (such as Global Insight) foresee continued economic growth in China at around 7 or 8% forthe medium term, (16) China could encounter a political or security crisis (e.g., over Taiwan independence), a bankingcrisis, internal unrest, or just a hard landing from its rapid rates of economic expansion that couldderail the optimistic projections that are the conventional wisdom of most China watchers. In no area is the mix of economics and security more intertwined than across the TaiwanStrait. China's strategy has been to maintain a truculent position against Taiwan independence withcredible threats of military action against what Beijing considers to be a "renegade province" shouldTaiwan attempt to make its de facto quasi-independent status into one more de jure . China hasbacked up its rhetoric by deploying an estimated 600 missiles that can be aimed at Taiwan along thesouth China coast and augmenting its ability to launch naval attacks. On the other hand, the PRChas encouraged Taiwan businesses to invest in the PRC in the hope that the increasing economic andfinancial interdependence would ameliorate the political forces for independence. In a white paper,Beijing said that with respect to Taiwan, "doors have been flung open to facilitate the flow of goodsand people. Businessmen from Taiwan are welcome to invest or trade on the mainland. They areaccorded preferential treatment and legal safeguards." (17) By creating a dependency by Taiwan's businesses on Chinese workers, subsidiaries, sourcesof supply, and markets, China has sought to win the "hearts and minds" of Taiwanese businessinterests. In the process, however, China also has created its own dependency on Taiwanesebusinesses -- particularly in information technology industries -- for advanced technology,manufacturing methods, and export channels. Cross-Strait relations occur at various levels. As shown in Figure 6 , the strata of interactionbetween the PRC and Taiwan begin at the human or individual level and increase in the degree ofinstitutionalization through economic interaction, diplomatic/political, and finally military. Allcross-strait interaction takes place in a context of clashing attitudes that includes a rising sense ofa separate national identity in Taiwan and a strong sense of territorial integrity and sovereignty inthe PRC. Figure 6. Temperature, Strata of Interaction, and Influence in Relations Between thePeople's Republic of China and Taiwan Human and individual interaction tends to be the least institutionalized and entails littlegovernment action (except to allow it). It includes direct human interaction, communication,development of attitudes (particularly nationalism and national identity), media, Internet, and familyties. Some indicators of the extent of human interaction across the Taiwan Strait are that in recentyears around 13 million Taiwanese have visited the PRC and more than 250,000 people from thePRC have visited Taiwan. (18) In January 2003, the first charter flights flew between Shanghaiand Taipei via Hong Kong to take Taiwanese business people home for the New Year holidays. (19) Flights were renewed forthe spring festival in 2005. The interaction also includes more than 210,000 marriages -- mainlybetween Taiwanese businessmen and Chinese women -- with 90,000 PRC spouses now living inTaiwan. (20) Thiscoincides with a multitude of other person-to-person contacts, reunions of relatives, communication,and entertainment. At this level, the temperature of interaction is mixed. For communications, travel, and familyties, it is warm, while in terms of nationalism, the movement in Taiwan toward a national identityseparate from that of China and in attitudes toward each other, the temperature is cool. Human andindividual interaction affects government policy on each side only as it is transmitted upward andinstitutionalized. Conventional wisdom holds that the more democratic and representative agovernment, the more influence such interaction is likely to have on national policy. Popularpressures on Taipei, therefore, may be relatively stronger than those on Beijing. But even decisionmakers in Beijing and elsewhere in China are experiencing increasing constraint from publicsentiments. Also for Beijing, the widespread and strong attitudes toward territorial integrity andsovereignty place further constraints on the shape any resolution the Taiwan problem can take. Human interaction often occurs within the context of the next higher stratum: economic andfinancial interaction. Economic and financial interests drive engagement at this level. Thetemperature of this type of interaction is very warm -- even hot -- with contacts extensive andgrowing. While governments determine the extent to which their economies are open to foreigntrade and investments, businesses and individuals usually conduct actual transactions independentlyof government action. In economics and trade, both Taiwan and the PRC hold strong leverage overthe other. The two economies complement each other and depend on each other for financing,technology, labor, and manufacturing expertise. Taiwanese businesses have invested between $70billion and $100 billion in the PRC -- about half of all Taiwanese overseas investment. About amillion Taiwanese businessmen and their families reside in China -- some 400,000 in the Shanghaiarea alone. China has not been as free to invest in Taiwan, but even that is gradually opening up. As the host of Taiwanese investment and because of the mutual dependency that has developed,Beijing holds Taiwanese businesses in a situation somewhat akin to a "hostage." In case ofhostilities, Taiwanese businesses cannot just pull up stakes and go home. Taiwan, however, also hasleverage over Beijing. Without Taiwanese expertise, China would have a difficult time developingcertain of its high technology industries. This mutual dependency is readily apparent in the information technology (IT) sector.Taiwanese companies have invested heavily in manufacturing facilities in the Pearl River Deltaadjoining Hong Kong and, more recently, in Shanghai. In 2003, 60% of Taiwan's IT hardware wasmade in the PRC. Taiwanese-invested companies in the PRC produced more than 70% of theelectronics made there. (21) The United States, China, and Taiwan increasingly are becomingan integrated market for semiconductor manufacturing and consumption. Both the United States andTaiwan keep their highest levels of technology at home, but China has become a majormanufacturing platform for quite sophisticated computer chips. In semiconductor wafer foundries,for example, as of December 2004, eight of the nine major Chinese companies were able tomanufacture 8-inch wafers. Two were making the latest generation of 12-inch wafers. Their sourcesof technology were Taiwanese (Taiwan Semiconductor Manufacturing Co., UnitedMicroelectronics), European (Philips, Alcatel), and Japanese (Oki, Sanyo, NEC, Fujitsu). (22) Taiwan also has allowedits companies to transfer production of notebook computers to China. China and Taiwan togetherdominate production of motherboards (72% global market share), graphic cards (77%), PC notebookcomputers (62%), flat panel monitors (67%), and are major producers of optical disk drives (41%),cellular phones (33%), ink-jet printers (53%), and PC desktop computers (23% of the global market)with most of each share being produced in China. (23) For years, both sides restricted interaction, particularly any that involved the transfer ofhigh-level technology. As China has liberalized its trade and capital markets, however, strongbusiness pressures have developed in Taipei to do the same. For example, in 2002, after extensivelobbying by major Taiwanese semiconductor companies, the government in Taipei relaxed its banon investments in semiconductor facilities in the PRC. Business also have asked Taipei to permitChinese nationals to work for high-technology companies in Taiwan (which had beenprohibited). (24) InJanuary 2001, the two sides established the "three mini-links" which permitted direct transportation,commerce, and postal exchanges between two Taiwan-controlled islands and their coastal Chineseneighbors. In October 2001, Taipei announced new visa procedures that make entry and workingin Taiwan easier for PRC professionals. Other events in cross-strait relations have included thedecision by oil companies in the PRC and Taiwan to explore jointly offshore areas for oil andTaiwan's opening to third-country and selected PRC and Taiwanese ships to carry cargo to and fromdesignated ports in Taiwan and in the PRC (25) In 2001, Taipei replaced its "be patient" policy for dealing withtwo-way flows with China with one of "active opening with effective management." As shown in Figures 1 and 2 , trade between the PRC and Taiwan has been growing rapidly. China is now Taiwan's largest export market, and Taiwan runs a trade surplus with the PRC of about$25 billion. Because of goods flowing through Hong Kong, each side reports different numbers, butboth indicate a rapidly rising trend. Both imports and exports have increased dramatically. Taiwan'simports from the PRC have risen from $3 billion in 1995 to $16.7 billion in 2004. Over the sameperiod, China reported that imports from Taiwan rose from $15 billion to $64.7 billion, whileTaiwan reported a comparable rise of exports to China of $0.4 billion in 1995 to $34.0 billion in2004. Since joining the World Trade Organization, Taiwan increased the items allowed to beimported from China from about 2,000 to over 8,500 (78% of total items produced) in 2004. (26) The extent of Taiwan's rising integration and dependency on the PRC economy has been acause of great concern in Taipei. The government there has attempted to diversify investments awayfrom China with a "go-south" policy (invest in and trade with Southeast Asia instead of China), butthe allure of the PRC with its low-cost labor, common language, and economic incentives continuesto draw in businesses. Taipei cautions its businesses about the risks of investing in the PRC, butonly intervenes to keep the latest technology from migrating there. (27) At the diplomatic and political level, cross-strait relations have been cold (frigid). Beijingis using its rising economic and political clout as leverage in furthering its diplomatic agenda. Chinahas held the upper hand in barring Taiwan from membership in most major internationalorganizations (Taiwan's accession to the World Trade Organization was as a separate customsterritory) and from receiving diplomatic recognition from the major countries of the world. The PRChas been particularly aggressive and uncompromising, even going so far as blocking Taiwan fromreceiving unofficial observer status in the World Health Organization and preventing the presidentof Taiwan from attending the annual meetings of the leaders of the 21 member states at the AsiaPacific Economic Cooperation forum. China's diplomats also are taking the lead in regionalmeetings, and China's economic clout is inducing countries that previously recognized Taiwan toshift their diplomacy toward Beijing. (28) Taiwan, on the other hand, has also been pressing for more roomto maneuver on both the diplomatic and political levels. President Chen Shui-ban has emphasizedthat Taiwan is a sovereign state and should not be downgraded, marginalized, or treated as a localgovernment. (29) Overhanging the diplomatic and political level of interaction is the constant threat of militaryaction as a deterrent, coercive force, and other means to forcibly accomplish what peaceful methodsmay not achieve. Partly in response to what Beijing views as Taiwan's inching toward independence,in March 2005, China enacted an Anti-secession Law codifying the use of force against Taiwanshould it move toward formal independence. (30) At the military level, therefore, cross-strait relations are cold. The Pentagon reports that after close to 20 years of spectacular economic growth in China, Beijing'sdiplomatic successes, and steady improvement in China's military capabilities, the cross-Straitbalance of power is steadily shifting in Beijing's favor. (31) For Taipei, the strategy is to maintain "effective deterrence"through "resolute defense" and to avoid having the military balance tip toward Beijing. (32) Taiwan's Ministry ofNational Defense, in its biennial defense report, places the possibility of a direct attack by the PRCacross the sea as low, but warns of the PRC military buildup and the likelihood that an imbalancein the PRC's favor may induce Beijing to attempt to resolve the Taiwan issue through militarymeans. (33) The critical deterrence factor against military action has always been the weight of wardamage and possible intervention by the United States. These factors still are preeminent, but thediplomatic, political, economic, and human costs of open hostilities have reached a level far beyondthat of years past when China was more isolated and less interconnected with the rest of the world. Some in Beijing have indicated that they would fight to retain Taiwan regardless of cost. InDecember 2003, a leading Chinese military strategist warned that a decision to attack Taiwan wouldnot be affected by concerns about China's economic development and that Beijing was not concernedthat foreign investment might drop or that an attack would set back its development by severalyears. (34) China's 2004report on national defense states that Taiwan's independence movement is the greatest threat toChina's sovereignty and is something that must be stopped "at any cost." (35) These references to thecost of open conflict with Taiwan seem to reflect the growing tension within China between themilitary and business and international trading sectors. A Chinese observer in a think tank inShanghai, moreover, cautions that even though economic and financial ties are having a positiveeffect on security ties, in reality, the effect still is small. Right now it is more "hope thanreality." (36) The fact that China has not resorted to force to achieve one of its major national goals,however, indicates that Beijing currently can ill afford overt hostilities. The military deterrent, ofcourse, is always in play, but as seen from the Taiwan side, other considerations are causing stabilityin the cross strait relationship to continue. First, the Chinese need stability to continue economicdevelopment, attract investment and deal with the challenges of WTO accession as well as withdomestic problems such as unemployment and the urban-rural divide. Second, the internationalbusiness community also wants stability in the region for business reasons -- a message they haveconveyed to both Beijing and Taipei. A third reason is that Taiwan also needs stability to conductits own internal political and economic reforms. (37) Hence, neither side is opting for overt hostilities. The Taiwan side points out, however, that whether the growing economic interdependenceacross the strait combined with other deterrent forces leads to stability or instability depends onwhether Beijing's decision makers are rational or irrational. If they are rational (as viewed byTaiwan), a cost-benefit analysis would likely overrule an unprovoked military action against Taiwan. If they are irrational (as viewed by Taiwan), however, anything can happen. History has shown thatin campaigns, such as the 1966-76 Cultural Revolution, rationality (as might be viewed by others)does not always prevail in Beijing. (38) One author who has examined the integration of the information technology industry betweenTaiwan and the PRC concludes that in addition to the fatalities and casualties resulting from openhostilities, a cross-Strait war would devastate Taiwan's economy and severely harm China'sindustrial progress. He points out that such a war also would cripple the digital economies of everydeveloped economy in the world. His argument is that all international commerce depends onsilicon-based computer and communications systems, while industries depend on new informationtechnology products for future productivity gains. A cross-Strait war would suddenly cut into muchof the world's supply of silicon-based products essential for global commerce and investments in newtechnology. The author surmises that any use of force to reunify China would cause such a jolt tothe world economy that the United States would be forced to intervene preemptively to preventit. (39) Another study points out that China's desire to attract investment and technology fromTaiwan is likely to decrease the likelihood of conflict in the Taiwan Strait by "making the costs ofany potentially provocative move prohibitively high for both sides." In short, economic integrationhas made war so costly that neither side would "risk contemplating any action that might ignite aserious conflict." (40) In a separate study, a Taiwanese professor points out that while cross-Strait integration hasgenerated spill-over effects in terms of broadening exchanges to areas untouched in the past,economic integration has not resolved the sovereignty issue. It also, in his view, has precluded theChen administration from making bolder moves toward independence because of Taiwan'sdependence on the Chinese market. This professor believes that Beijing has become more confidentand assertive and appears willing to promote economic and other exchanges without attachingpolitical strings as was the case previously. As it gains economic power, Beijing is feeling "morecomfortable in relying on economic means to achieve its political goals." (41) Former National Security Advisor Henry Kissinger sees a type of historical evolution takingplace as more and more of the Taiwanese economy is connected with the PRC and more and moreexchanges take place. Over a period of ten years or perhaps more, he says, the conditions of life onthe two sides of the Taiwan Strait will become more comparable, and the dialogue on the politicallevel, therefore, easier. He does not feel the problem will be resolved by economic exchanges, sincepeace across the Strait depends on a political solution and an understanding of what is required forpeace in Asia. (42) Many military authorities continue to emphasize the risk that a cross-Strait crisis couldtrigger a global conflagration. What can be concluded is that the stakes of overt hostilities are nowhigher and that the cost-benefit calculation extends over all levels of interaction -- not just themilitary. The bilateral relationship between China and Japan is shifting dramatically. There is growingand consistent interaction at the human and economic level shaded by considerable political frictionand historic tension as well as occasional naval clashes. As depicted in Figure 7 , the temperatureof interaction at the human and individual level is mixed. Communication and cultural exchangestend to be warm, but anti-Japanese sentiments and nationalistic incidents in China continueemphasize the iciness of human relations. At the economic and financial level, however, relationsare hot. These comprise the bulk of interaction, are self motivating, and take place without muchofficial notice or fanfare. At the diplomatic and political level, relations are tepid -- not warm butnot cold either. China is supplanting Japan as the leader in Asia, and Japan is having to cedediplomatic territory to Beijing. Many in Tokyo are taken aback at what they consider to be highhanded actions by Chinese leaders and their use of historical animosities that many in Japan feel aregenerated by the government-controlled Chinese press and educational system. (43) Prime Minister Koizumiof Japan has taken some actions that rile Beijing to underline the point that Japan is a leadingindustrialized nation and acts according to its own interests despite objections from China. At themilitary level, relations are cold as both countries seek to establish their claims to offshore islandsand Japan watches the Chinese military buildup with deep apprehension. Figure 7. Temperature, Strata of Interaction, and Influence in Relations Between thePeople's Republic of China and Japan As discussed previously, trade and investment relations have surged in recent years. Japan'seconomic recovery has been maintained partly by exports to China, and Japan's businesses also haveincorporated China as an important manufacturing platform for their products. Including HongKong, Japan now trades more with China than with the United States. Statements by both Beijingand Tokyo indicate the desirability of mutually beneficial trade. On the political side, however, tensions are high on a variety of historical and sovereigntyissues, and many observers see a potentially destabilizing spike in nationalist animosity toward Japanamong Chinese. Political and diplomatic relations are intertwined with historical grievances,particularly those centered around Japan's behavior during and preceding World War II, that continueto surface in the bilateral relationship. The most consistently divisive issue involves the visits ofJapanese politicians to the Yasukuni Shrine, a Shinto shrine in Tokyo that honors Japanese who diedin war. Those whose names are enshrined there include several Class A war criminals. Chineseleaders have emphasized repeatedly that Prime Minister Koizumi's Yasukuni visits constitute a hugestumbling block in moving political relations forward. On August 15, 2004, the anniversary ofJapan's surrender in World War II, four cabinet level officials and 58 Diet members visited thecontroversial shrine. In response, the Chinese Foreign Ministry stated that "the political basis forChina-Japan relations is for both nations to have a correct understanding of that previous time." (44) In April 2005, large-scale anti-Japanese demonstrations broke out in at least nine Chinesecities, including a violent protest in Shanghai that damaged the Japanese consulate as well as shopsthat catered to the large Japanese expatriate community. Many observers noted that the Chineseauthorities were unusually passive in allowing the protesters to organize, fueling speculation thatBeijing quietly encouraged the demonstrations to channel dissatisfaction at its own governancetoward a foreign target. Koizumi's fifth annual visit to Yasukuni on October 17, 2005, again drew angry protests fromAsian leaders: both Beijing and Seoul cancelled upcoming bilateral meetings with the Japanese, butin China no widespread anti-Japanese demonstrations occurred. Some observers noted attempts byKoizumi to tone down the symbolism of the visit with less formal clothing and ceremony, perhapsas a concession to domestic pressure from pro-business interests who fear antagonizing China. Koizumi may also have been responding to an Osaka High Court ruling earlier in the month whichclaimed that his visits as Prime Minister to Yasukuni constituted a violation of the constitutionalseparation of church and state. Some reports have noted that the existing separation of church andstate has been weakened in the draft revision of the constitution recently submitted by the governingLDP. Since the mid-1990s, Tokyo and Beijing have feuded over Japanese history textbooks forschool children. China and other Asian countries insist that the texts misrepresent Japan's past bydownplaying the atrocities committed by Japanese soldiers against civilian populations. Whenthen-President Jiang Zemin visited Japan in 1998 -- the last time a head of state of either countryvisited the other -- he warned the Japanese hosts not to forget history. (45) Furthermore, Japan'scampaign to gain a permanent seat (without veto power) on the United Nations Security Council isfacing opposition from Beijing. (46) Even brushing aside disputes over territory and history, the medium and long-term outlookfor stable security relations is uncertain. Recent Japanese defense documents and officials have citedconcern about China's ongoing military modernization. Japan's Defense White Paper noted a needto pay attention to the modernization of China's People's Liberation Army (PLA). In writing Japan'sNational Defense Program Outline (NDPO) for 2004, three scenarios in which China attacks Japanwere posited: a confrontation over marine resources, territorial conflict in the Senkaku Islands, andan extension of a China-Taiwan conflict. (47) Japan's military thinkers, however, view a direct invasion of theJapanese mainland as quite unlikely at this time. (48) A variety of other sensitive sovereignty issues have dominated recent bilateral relations. OnNovember 10, 2004, the Japanese Maritime Self Defense Forces were sent to interdict and track aChinese nuclear submarine that had been detected in Japan's territorial waters close to Okinawa. Theincident prompted harsh criticism from both the ruling and opposition parties in Japan. Maritimeresearch activities conducted by China in the East China Sea near the Exclusive Economic Zone(EEZ) claimed by Japan alarmed Tokyo and sparked debate during Japan-China ministerial talks. Expressing concern that China's development of natural gas fields would laterally siphon offresources from Japan's claimed territory, Japan began its own survey activities in July 2004. Chinahas also reportedly carried out other naval activities which have crossed into Japan's EEZ, promptingsome lawmakers to call for an increase for Japan's Coast Guard to protect the area around thedisputed Senkaku/Diaoyu islands. In October 2005, there were reports that China completedconstruction on and had begun operating at least one new drilling platform in the contested area. Shinzo Abe, Deputy Secretary General of the ruling Liberal Democratic Party in Japan, hasbeen quoted in press reports as saying, "the conventional wisdom is to regard China as a threat onthe military front." In addition, many analysts say that Japan's adoption of a missile defense system,as outlined in the Araki Commission report, creates a fundamental strategic conflict with China. Ina separate development, following ministerial meetings in Washington, DC on security, the UnitedStates and Japan stated that a common strategic objective was to "encourage a peaceful resolutionof issues concerning the Taiwan Strait through dialogue." (49) This was a rare statement by Japan of its interest in stabilityacross the Strait and was viewed in Beijing as "brazenly interfering in China's internal affairs." (50) Beijing also has criticizedthe strengthening U.S.-Japan security relationship even as the three countries work together in theSix-Party Talks to deal with North Korea's nuclear weapons programs. An obstacle to improved relations may also be a rising tide of nationalism among youngChinese. Although China's indignation at Japan's military occupation of the country in the 1930'sand 1940's has long been expressed by the state-controlled Chinese press, observers have noted a risein anti-Japanese fervor among the younger generation. Hostility towards the Japanese crystallizedat the Asia Cup soccer finals in August 2004, when Chinese fans yelled violent anti-Japanese chants,threw bottles at the team bus, and burned the Japanese flag outside Japan's embassy in Beijing. Rising Internet usage may also play a role as networks of young nationalists have formedonline. (51) In anotherexample, isolated remarks by the governor of Kanagawa Prefecture that Chinese holding studentvisas were "sneak thieves" spread quickly over the Internet through Chinese chat rooms. A Japanese observer of major trends sees China as the single most formidable challenger toJapan. Although private economic relations are thriving, he sees rising friction at the governmentlevel. The two countries maintain a type of "cold peace," as China matures and attempts to reclaimits position in the world. (52) Despite considerable tension between the political leadership, however, there appears to havebeen greater efforts to handle conflict and discord in the past few years. China's Vice-ForeignMinister reportedly expressed regret for the November 2004 submarine incursion into Japanesewaters, citing "technical problems" that had caused the submarine to veer accidentally into Japanesewaters. (53) In 2004, threeof the thorniest wartime-related issues were resolved, generally in favor of the Chinese side. In thecourtroom, the Hiroshima High Court awarded full damages to Chinese wartime forced laborersbased on the violation of the plaintiffs' human rights. In a second case, a company settled withanother group of Chinese wartime laborers on similar charges. After the Chinese Foreign Ministry complained to Japan that artillery shells from the Japanese Imperial Army were still injuring Chinesecitizens, Japan acknowledged that the shells belonged to its erstwhile army and dispatched aweapons excavation team to central China. Other government initiatives have suggested a priority on bettering bilateral relations. China's ambassador to Japan, Vice-Foreign Minister Wang Yi, is considered to be a potential futureforeign minister, and is particularly well-regarded as an Asian specialist. Japan also recentlyexpanded Chinese citizens' eligibility for 15-day tourist visas to visit Japan. Although Koizumi andHu have not exchanged bilateral visits, they have met on the sidelines of other internationalmeetings. Parliamentary exchanges also have been active, with over 100 representatives from boththe LDP and Democratic Party visiting China following the 2004 Diet session. House ofRepresentatives Speaker Yohei Kono received the red carpet treatment and met with top leaders inBeijing in September 2004. The rocky patch in Sino-Japanese relations coincides with the United States asking more ofJapan's military, including an overseas deployment to Iraq and active involvement in supportingcoalition forces in the Afghanistan theater. Much of Japan's defense establishment has embraced theconcept of Japan's defense forces becoming more active in maintaining regional and global stability. Many Chinese officials view the developments warily, particularly the anticipated debate in Japanon amending Article 9 of the constitution, which renounces the use of force to settle disputes. Analysts surmise that internal debates on how to best approach the regional rivalry go on inboth capitals. In Tokyo, the disagreements are more transparent: figures such as former LDPSecretary General Koichi Kato and House of Representatives Speaker Yohei Kono have bothpublicly urged Koizumi to take China's concerns into consideration when deciding to visit YasukuniShrine. During Kono's visit to Beijing in September 2004, he expressed regret that the bilateralrelationship was far more mature economically than politically. (54) In Beijing, the debate iscarried out in less explicit ways. Some government-affiliated think tanks have advocated a morepractical, less emotional approach to relations with Japan. The Strategy and Management Journal ran a series on Sino-Japanese relations in 2003 that highlighted the economic importance of therelationship and suggested a need to move beyond historical disagreements. However, someobservers say that Chinese policy-makers, constrained by simmering public resentment towardsJapan, are unwilling to take the political risk of appearing "soft" on Japan. Others surmise thatBeijing uses anti-Japanese sentiment and allows popular demonstrations as a means to enableChinese to "let off steam" rather than direct their frustrations and anger toward the ruling communistparty. Economic competition between China and Japan also is playing out in various ways uponthe international scene. In view of China's increasing economic muscle and diplomatic friction withJapan, in 2005, Tokyo informed Beijing that it plans to phase out its yen aid loans (actually a formof war reparations) by 2008. These loans comprise some 90% of all Japanese aid to China and seemunnecessary for a country that itself is becoming a major aid provider. (55) Also in 2004, Russiachose Japan over China as a future oil customer by announcing that it would build a pipeline carryingSiberian oil to a Japan Sea terminus instead of to China. (56) In Japan, economics and politics always have mixed. In many respects, the U.S. nuclearumbrella has allowed the country to pursue "checkbook diplomacy" by which Tokyo has used itstrade, aid, and investments along side the strengthening of its military to develop what they havecalled comprehensive security. Japanese experience in the 1980s showed that while economicinterdependence may not deflect trade and political friction, it puts incentives in place to resolvedisputes amicably. Economic and financial relations formed a base from which Japan couldapproach diplomatic, political, and security relations with other states. (57) For both Japan and China, one key question is to what extent the extensive economicinteractions and diplomatic sensibilities will prevent political tension from escalating into outrighthostility or even military conflict. Some experts point to tentative evidence that Japan-Chinasecurity relations are stabilized by growing economic ties. One study of the Sino-Japaneserelationship concludes that cooperation in the economic realm has not developed into cooperationin the security realm, but the author also notes that confrontation in the security realm also has notbrought friction in economic relations. Japan's China policy is striking a balance between militarysecurity and commercial policy. (58) Another study concludes that economic interaction has, on thewhole, proven effective in promoting stable political relations. The economic nexus has not onlyprovided the foundation for the political relationship, but it has served to maintain that relationshipduring times of trouble. In times of crisis (such as the 1989 Tiananmen Square crackdown), Japan'spolitical retaliation was scant so as not to disturb the economic synergy and political stability. Theauthor also concludes that as the two economies become more profoundly intertwined with eachother, they are likely to reach out to each other in areas such as regional security affairs in order tomaintain the peace. (59) One example of such cooperation could be China's cooperation with Japan (and the United States,South Korea, and Russia) in the Six Party Talks on North Korea. In short, economic interaction appears to have induced the two sides to keep the politicalrhetoric to a manageable level and adroitly tiptoe around potential military clashes. Both sides,however, continue to build their military capabilities. The question, then, becomes whethereconomic and cultural ties will continue to induce military restraint as China grows into a majorregional power and Japan begins to deploy its military outside of its homeland defense perimeter. Another question is whether economic and cultural ties will overcome historical animosities orwhether economic ties, themselves, will become a target of boycotts and popular demonstrations ineither country. The relationship between China and South Korea (The Republic of Korea or ROK) providesa model for how deepening economic relations can bring two capitals together politically. Figure8 outlines the major strata of interaction, channels of influence, and the temperature of relationsbetween the PRC and South Korea. As is the case with Japan, the major daily interaction is incommunications and economics while disputes over historical issues occasionally cloud therelationship. At the human and individual level, the temperature of relations is mixed with risingwarmth in cultural exchanges and communications but occasional cooling in nationalistic disputes. Cultural ties have also increased multifold: tourism in both directions has increased markedly, andthe number of South Korean students studying Mandarin has skyrocketed. Historical ties betweenChina and South Korea are not as fraught as those between China and Japan, but disputes stillsurface. The temperature of economic and financial relations has been hot as China has displaced theUnited States as South Korea's major trading partner, and South Korean businesses have movedlabor-intensive production processes to Chinese factories. Each economy has grown increasinglydependent on the other for trade and investments. In 2004, South Korea exported $49.8 billion ingoods to China, $42.8 billion to the United States, and $21.7 billion to Japan, while importing $46.1billion from Japan, $29.6 billion from China, and $28.8 billion from the United States. (60) At the diplomatic and political level, relations have generally been warm (cordial) since thenormalization of ties in 1992, but disputes over treatment of North Korean refugees seeking passagethrough China and other issues have sometimes cooled relations. Frequent reciprocal visits by topofficials have solidified the Figure 8. Temperature, Strata of Interaction, and Influence in Relations Between the People's Republic of China and South Korea political relationship, and cooperation in attempting to resolve the NorthKorean nuclear crisis has gained Beijing further favor in Seoul. Korea's history with China is not always viewed as a positive influence on contemporarybilateral relations. A controversy in 2004 over the origins of the Koguryo Kingdom sparked a majorpolitical dispute, the largest since the normalization of relations. The flap arose because of a PRCclaim that the Koguryo Kingdom (37 B.C. - 668 A. D.) was a part of Chinese territory and history,not, as Koreans claim, an independent Korean entity that produced many of Korea's long-standingtraditions. Angry reaction in South Korea came from many quarters, including the public, membersof the National Assembly from both parties, and the Ministry of Foreign Affairs and Trade. Manyclaimed that the controversy exposed Beijing's "hegemonic ambitions," and erased an earlierimpression of China as a benevolent economic partner. (61) Officials on both sides scrambled to calm the controversy andBeijing dispatched Vice Minister Wu Dawei, former ambassador to South Korea, to negotiate aresolution. The resulting five-point agreement soothed Korean concerns at least temporarily. Withthe North Korea problem still at a sensitive stage, government officials were relieved to patch up therelationship. Still, the incident exposed strong underlying sentiment in both populations and couldindicate a shift away from the cozy political relationship the two capitals enjoyed for over a decadesince normalization. At the military and security level, relations are cool but warming. Despite China'sintervention in the Korean conflict and alliance with North Korea, security relationships betweenSeoul and Beijing are improving. In 1999, China and South Korea agreed to hold annual discussionson regional security issues. (62) China holds a large wild card in the security relationship becauseof its influence with Pyongyang. Similar to Japan, however, South Korea also is concerned aboutthe potential adverse behavior of China two or three decades into the future when it is expected toachieve major power status. The threat of instability posed by the North Korean nuclear program has induced the majorpowers in the region to cooperate in bringing Pyongyang to the negotiating table. These six-partytalks build on common security and economic interests and have brought the governments of Chinaand South Korea into a loose partnership. Both countries oppose the development of a nuclear armsprogram by North Korea. Each fears the consequences of a collapsed Kim regime in Pyongyangwhich could create instability for their own governments. Because Japan generally has hewedclosely to the more hardline U.S. position, Seoul and Beijing have found themselves advocating asimilar approach of engagement and laying out in explicit terms what Pyongyang could gain if itabandoned its nuclear weapons program. Observers note the irony that with respect to the NorthKorean nuclear issue, Sino-North Korean relations have become somewhat of a burden for Beijingwhile ties with South Korea have become economically beneficial. The two countries have foundthis common ground despite strong disagreement on how to handle current North Korean refugeeswho try to defect to third country embassies in China in attempts to gain passage to South Korea. As in the case with Japan, the U.S.-South Korean military alliance weighs heavily on thegrowing ties between Beijing and Seoul. In essence, both have been able to deepen the economicrelationship with full knowledge that the United States also seeks stability in Northeast Asia. Chinaand South Korea's cautious political alignment on the six party talks has taken place, however, ascracks have begun to appear in the U.S.-South Korea alliance. With the election of President RohMoo-Hyun and the subsequent victory of his Uri Party in the National Assembly elections, some inSouth Korea and elsewhere have seen a shift from Washington to Beijing as Seoul's favored partnerboth economically and diplomatically. South Koreans who favor a stronger partnership with Chinapoint out the cultural and historical affinities, economic interdependence, and the similar desire to maintain stability in the region, including keeping Japan from resuming a more forward defenseposture. However, both Washington and Seoul policymakers insist that the alliance is strong, andPresident Roh has kept his promise on sending troops to perform humanitarian work in Iraq. Disagreements over the global realignment of U.S. forces that will change U.S. military presence inSouth Korea appear to have been smoothed over with further consultations and compromises.Although China may look like an appealing alternative when relations with the United States waver,some observers point to China's history of shifting alliances, as well as its entry into the Korean Warin 1950 that ultimately preserved the division of the peninsula. Further, China has not yet acceptedSeoul's 1999 proposal to hold joint maritime search and rescue exercises, (63) although talks havecontinued. One indicator of the warming relations between Seoul and Beijing is the Roh administration'snew geopolitical strategy (with the support of China) of seeking to play the role of a balancing forcein Northeast Asia. President Roh reportedly would like South Korea to play the role of stabilizer forpeace and prosperity and to place exchanges between South Korea and China on the same level asthose with Japan. While Korean officials insist that ties with the United States remain unchanged,concerns have been voiced that this strategy implies a shift toward China -- possibly because ofpolicy differences with the United States. (64) Expert studies also point to the growing strength of the economic relationship in Chineseforeign policy. One expert concludes that since successful implementation of reform and open-doormeasures for China requires stability, Beijing has few options other than to pursue a pragmaticdiplomatic policy rooted in economic benefits, although clearly China shows no intention ofcompromising or negotiating over matters related to its sovereignty. In this respect, China regardspeace and stability on the Korean peninsula as indispensable to its continued economic advancement. It seeks to preserve the Pyongyang regime while taking measures to resolve the North Koreannuclear problem. Also, the talk of reunification between South and North Korea places pressure onBeijing to keep on the good side of South Korea to avoid the prospect of a nuclear-armed, unifiedKorea as an unfriendly neighbor. The PRC also would like to wean South Korea away from its closemilitary alliance with the United States in order to weaken what it views as an important link in theU.S. "encirclement" of China. Beijing, therefore, has placed great importance on its economic andtrade relations with South Korea while maintaining its support of Pyongyang and expandingdiplomatic and political contacts with Seoul. (65) From the above discussion, it is apparent that the rise of the PRC as an economic powerhousehas brought significant changes in China's relationships with Taiwan, Japan, and South Korea. Theinterests of all four of these governments are being influenced by the rapid development of trade,investment, and financial flows. These relationships are self-motivating, self-perpetuating, andself-sustaining. They arise primarily out of the self interests of businesses and operate largelyindependently of government intervention (except for government regulation, ownership ofenterprises, and financing). Many of these economic flows are generated by the forces ofglobalization that are affecting all parts of the world. Within the four strata of interaction (military,diplomatic, economic, and human), economic relations between China and the other states are thewarmest; human interaction is both warm and cool; diplomatic relations range from warm to cold,and military relations generally are cold or absolutely frigid. The Chinese economy is growing so fast and becoming so large that other Asian countriesare jumping on the bandwagon to ensure that their industries both capture some of the Chinesemarket and use the low-cost Chinese manufacturing platform to keep their exports competitive inthird country markets. Governments in the region are increasing their economic engagement withChina while hedging their bets by strengthening their own military forces to offset the arms buildupin China. They are keeping military clashes that do occur -- often related to claims to disputedislands -- from escalating into political crises. China is increasingly engaging in strategiccooperation, particularly in the global war on terrorism and in using its influence with North Koreain hosting the six-party talks. Potential flashpoints, however, still exist -- particularly across theTaiwan Strait and with North Korea -- and a menacing frown could appear from behind China's"smile diplomacy" once the PRC modernizes its military and reaches its goal of becoming amid-level industrialized nation. Throughout northeast Asia, however, the costs of disrupting economic and financial activityby a military or other crisis are rising. This is not to assert that economic activity stops wars, sincetrade between Britain and Germany certainly did not prevent either world war in the last century. The situation now, however, is fundamentally different because industrial processes are integratedacross countries; financial markets are global; and people are more mobile. Disrupting economicrelations between Taiwan and the PRC, for example, not only would affect their trade in computers,cell phones, and other final products, but it also would affect the global information technologyindustry and production processes in other countries (including the United States) that rely on Chinaand Taiwan for critical components. The main concerns with respect to rising Chinese economic power and the growing trade andinvestment network in northeast Asia seem to be: China's so-called "peaceful rise" is occurring below the radar screen for manypolicymakers. China seems to be taking advantage of a "distracted America" to build relationshipswith other countries that could have far-reaching effects on U.S. interests andstrategy. The growth of the Chinese economy is so rapid and broad-based that it has thepotential of fundamentally altering national interests among countries. It already is affectingeconomic relationships both among countries and within industries. China is displacing the United States as the primary trading partner for manyAsian countries. Everyone in Asia seems to be jumping on the "Chinese bandwagon." China'smarket has become so extensive that Taiwan, Japan, and South Korea have all joined theChinese-based economic network rather than try to work against it. While the U.S. market willalways be a major export destination, Japan, South Korea, and Taiwan have progressively turnedtoward China for imports and exports, and their companies increasingly are dividing theirmanufacturing processes to take advantage of lower costs in China. The progressively large economic and financial relationships between Chinaand its neighbors in northeast Asia is altering the cost-benefit calculus of military action that mightcause instability in the region. The economic costs of instability are rising. Each is being inducedto seek stability, although the PRC is adamant in preventing Taiwan'sindependence. China's growing economy provides the resources for Beijing to modernize itsmilitary, and it is expected, before too long, to be able to tip the balance of power across the TaiwanStrait in its favor. Once that occurs, China may be willing to sacrifice external peaceful relations toaccomplish other national goals -- such as forced reunification with Taiwan. While the economic, political, and military relations in northeast Asia occurlargely on separate tracks, the sheer magnitude of the economic flows is affecting relations at otherstrata of interaction. Already, economic interests have induced more cooperation on politicaldisputes between China and Japan and South Korea. While economic interests generally do nottrump security interests, they tend to induce countries to seek stability and refrain from taking rashmilitary or political actions that might lead to instability, sanctions, surcharges in internationalfinancial markets, and other penalties -- whether imposed by the market or by foreigngovernments. American interests in northeast Asia are a subset of the comprehensive U.S. interests ofsecurity, prosperity, and value preservation. These translate into specific U.S. goals of maintainingstability under a favorable balance of power, promoting democracy and access to markets, anddeveloping amicable and cooperative relations with other nations. In China the ruling communistparty has strong interest in maintaining its hold on power, enabling rapid economic growth,maintaining stability, and exercising sovereignty over what it considers to be its national territory. Japan and South Korea seek security and stability in the region, particularly with respect to NorthKorea and the growing military strength of China, rapid economic growth, open trade and investmentrelations, as well as to maintain their representative governments and systems of political pluralism. Taiwan shares interests in economic security; it is distinguished by an all consuming focus onmaintaining cross-Strait stability. For the United States, a question is how to promote and protectU.S. interests while northeast Asia undergoes rapid economic change. During the Cold War, the countries of Northeast Asia and the United States tended to makepolicy decisions relative to security, politics, and economics under a bipolar strategic lens that placedsecurity first in international relations. In most cases, the overriding question for the West waswhether the policy being considered added to or detracted from the containment of the Soviet Unionand curtailed the spread of both Russian and Chinese-style communism. This colored, for example,efforts to reconstruct post-World War II Japan, to intervene in the Korean conflict, to providesupport to the Republic of China on Taiwan, to escalate the Vietnam War, to sometimes wink attrade barriers in Japan and South Korea in exchange for their support of the U.S. military, and topromote closer trade ties with Japan and South Korea rather than have them rely on China, theirtraditional trading partner. During that time, the best predictor of whether a nation had amicablerelations with the United States was the degree to which it opposed communism. Now that the lastremnants of the Cold War are disappearing in Asia, national policy among countries in NortheastAsia seems to be evolving more to reflect the practical interests of individual states rather than theirideological bent. China's Deng Xiaoping stated it clearly when he said that it doesn't matter if a catis black or white, so long as it catches mice. For Congress, the rise of China presents several geopolitical policy choices. (66) These include whatstrategies the United States should pursue to accomplish long-term interests given that the economicrise of China is likely to continue and what combination of economic, diplomatic, and securitymeasures should be employed to best protect U.S. interests and accomplish particular U.S. policygoals. The policy choices with respect to northeast Asia include whether to: continue current policies of promoting market economies, enablingglobalization, and encouraging democracy while projecting sufficient military power to keep thepeace in the region; seek to contain China along the same lines of the containment of the formerSoviet Union; actively counterbalance the rising economic influence of China and the tradingnetworks it is building by pursuing free trade agreements and closer investment relations with Japan,South Korea, and Taiwan and by strengthening free trade process under the Asia Pacific EconomicCooperation (APEC) forum; bring China's external trade more into balance, ensure that China adheres toits World Trade Organization commitments, reduce the foreign exchange resources available toChina's central government, and slow the "bandwagon effect" by which Japanese, South Korean, andTaiwanese businesses are establishing factories in China with the intention of selling a part of theoutput in the U.S. market; facilitate the globalization of China in order to strengthen forces of change,create centers of power outside of Beijing, and increase representation in Beijing by business andinternational interests; and take into greater account the impact that the rise of China is having on thepolicies of Japan, South Korea, and Taiwan. Status Quo. Current U.S. policies toward theeconomic rise of China are based both on "idealism" and "realism." The Pentagon's militaryplanning, of necessity, tends to be power- and threat-based and realistic. It considers and preparesfor several scenarios, including the "worst case" in order to provide for the security interests of theUnited States. Current policies stress contingent military planning, export controls, strong alliancerelations with Japan and South Korea, and rising levels of engagement. Other U.S. policies toward China tend to be idealistic. They are aimed at promoting U.S.ideals of democracy, a liberal market economy, and human rights in China. Many of these policiesare based on the globalization-peace hypothesis (67) that posits a progression in the political and economicdevelopment of nations that starts from a low-level agrarian economy that becomes globalized andenters a phase of sustained economic development which then leads to the rise of a middle class(mostly urban) and to greater internal demands for democracy and representative government. Thehypothesis posits that democratic governments do not fight each other. Therefore, in this view,efforts to establish democracy ultimately lead to more peaceful relations with other nations. This isone rationale for current U.S. policies of liberalizing trade, facilitating China's membership in theWorld Trade Organization and other international institutions, encouraging communications at alllevels, and engaging Beijing on a multitude of fronts. Containing China. Those who focus on the Chinathreat often advocate a policy of deterrence and containment -- some have called it"constrainment." (68) This is analogous to the containment doctrine pursued by the West during the Cold War. Whilecontainment usually is couched in terms of military strategy, it also can extend to economic andpolitical issues. Certainly, China's economic rise has provided the resources for it to build a modernizing andmore powerful Chinese military. While the end of the Cold War and rapproachment with Russia hasreduced greatly the probability of a big-power conflict in Asia, the rise of China as a regional nuclearpower, in the minds of some, merely shifts the threat to China. The PRC also looks toward thePacific Ocean and sees U.S. forces in South Korea, Japan, and Guam with the Seventh Fleetsteaming around Taiwan and Southeast Asia. China is one of the few nations actively arming itselffor a possible military confrontation with the United States. (69) U.S. and Japanese militaryplanners are considering the implications of China as a military power and, for example, the mannerin which the two nations could address a possible China-Taiwan conflict. (70) Discussion of U.S.military strategy with respect to China, however, is beyond the purview of this report. On the economic side, containing China is like trying to put a genie back into a bottle. China's economy already has broken loose from most of its moribund communist strictures and hasbecome well integrated into the global economic system. Since the late 1970s, the PRC hasdeveloped from an inward-looking, protectionist economy to a world-class trading nation. Ratherthan China being constrained, the PRC is using its economic ties and cross border investments toensure that its influence spreads. China is coopting its neighbors with its trade and manufacturingresources. Taiwan is being forced to cope with the de facto integration of its economy with the PRC,and Japan, despite historical enmity by the Chinese people remnant from World War II, has littlechoice but to invest in China and incorporate the Chinese market into its trade and investmentstrategy. South Korea, despite the legacy of the Korean War and China's support of the regime inNorth Korea, has little choice but to enter the economic game with China. The United States,likewise, is increasingly dependent on the Chinese market as a manufacturing platform, an exportmarket, and as a buyer of U.S. debt securities. The Chinese economy is becoming the center weightof Asia. Any economy that does not hook into it runs the risk of being left far out of the action. Measures certainly can be pursued to ensure that China acts in ways consistent with its internationaleconomic obligations, but the PRC seems to have moved beyond the point where economiccontainment could be effective. Counterbalancing the Rising Economic Influence ofChina. There is little doubt that China is using its rising economic and politicalpower backed by its modernizing military to attempt to reduce U.S. influence in its periphery andto establish itself as the central power in the region. This is not only because Beijing has just nowgained the resources to allow the country to flex its muscles with credibility. A view in Japan andTaiwan, particularly among private-sector opinion leaders, is that China is taking advantage of U.S."inattention to Asia" to better position itself to become the leader of Asia and to wean neighboringcountries from their dependency on Washington and move them toward Beijing. Those who expressthis view assert that the United States needs to send a strong signal to countries in the region thatWashington is not distracted by the Middle East and that it has enduring interests in Asia. (71) There are many ways that signals can be sent. One is through realist channels such asmilitary strength and actual trade and investment flows. Another is through idealist channels suchas diplomatic and political contacts as well as multilateral institution building. On the realist side,bolstering U.S. alliance relationships and military capability as well as a full discussion of motivesfor U.S. troop reductions (those in South Korea were interpreted by many in Asia as indicating alower priority for Asia than for Iraq) could be useful. Also, measures to increase U.S. trade andinvestments in the region could help maintain or augment U.S. influence in northeast Asia. If Japan, South Korea, and China continue to move toward a free trade arrangement amongthemselves and with countries of Southeast Asia, the United States may consider speeding up theinitiation of discussions of bilateral free trade agreements (FTAs) with Japan, South Korea, andTaiwan. While such FTAs would not slow down the Chinese juggernaut, they might ensure thathigher U.S. tariff rates do not divert trade away from the United States and toward the region. Whilethe relatively low levels of U.S. tariff rates (about 2%) make trade diversion not a significantproblem, the proliferation of FTAs in the region could create shifts in trade flows away from theUnited States and toward the region. Of course, FTAs involve many more issues, (72) some negative and somepositive, than just a signal to China. The United States also may seek to reinvigorate the Bogor Declaration of the Asia PacificEconomic Cooperation (APEC) forum under which 21 economies bordering the Pacific Ocean areworking cooperatively to reduce barriers to trade and investment; ease the exchange of goods,services, resources, and technical know-how; and strengthen economic and technical cooperation. In the 1994 Bogor Declaration, the leaders of APEC declared their intention to establish free tradeand investment in the region by the year 2010 for industrialized members and 2020 for theothers. (73) In essence,the Bogor Declaration would create a huge Asia-Pacific FTA that would include both the UnitedStates and China. China's rising economic influence is occurring primarily at the expense of Japan. Despitethe fact that Japan still has the second largest economy in the world (third if the European Union iscounted as a single economy (74) ) and has a gross domestic product three times as large as China's,a decade and a half of recession has diminished the rising Japanese economic star considerably. Efforts to restart Japanese economic growth and to induce Tokyo to take a stronger leadership rolecould offset some of China's allure as a regional leader. Bringing China's External Trade More intoBalance. The United States could work more with nations of Asia and Europe tobring China's external trade more into balance. (75) Although China claims that it ran a surplus in 2004 of $33billion in its merchandise trade with the world, the United States alone incurred a deficit of $162billion and the European Union (15 countries) a deficit of $63 billion with China. Even when takingChina's surplus of $89 billion with Hong Kong -- much of which is entrepot trade that istrans-shipped to other nations, China's reported trade surplus seems to be understated. For 2005,preliminary data indicate that China's trade surplus tripled to $102 billion. (76) Regardless of the exacttrade figures, more might be done to ensure that China adheres to its World Trade Organizationcommitments (especially enforcement of intellectual property rights) and allows more flexibility inits foreign exchange rate (to reduce China's trade surplus and the dollar assets available to China'scentral government). A higher value for China's currency also could dampen the lure of the Chineseeconomy as a low-cost manufacturing platform that causes a "bandwagon effect" by which Japanese,South Korean, and Taiwanese businesses establish factories in China with the intention of sellinga part of the output in the U.S. market. These measures may not slow down China's growing tradeand investment network, but it could help to ensure that trade is conducted according to worldstandards. The current attention on the upward valuation of the Chinese yuan is a separate topic that isreceiving considerable attention already. (77) At a time that the U.S. dollar is depreciating in response to theU.S. current account deficit of around 6% of GDP, the peg of the yuan to the dollar shifts the burdenof adjustment to Europe, Japan, South Korea, and other countries. What is particularly ironic is thatthe bilateral U.S. trade deficit with China at $162 billion is not subject to the market forces normallyexerted by exchange rate adjustment. Also, since the Japanese yen and South Korea won already arefloating, the Chinese peg to a declining dollar gives Chinese exports a relative price advantage notonly in the American market but in Japan and South Korea as well. Between January 2002 andJanuary 2005, the dollar depreciated 22% against the Japanese yen and 20% against the SouthKorean won. Since the Chinese yuan has been tied to the dollar, it too has depreciated by likeamounts against the yen and won. This gives Chinese exporters an artificial advantage in Japaneseand Korean markets. In 2005, Beijing announced that it had dropped its currency peg. China said it had revaluedthe renminbi by 2.1% from 8.28 yuan to 8.11 yuan per dollar and that its currency would be"referenced" to a basket of currencies and allowed to fluctuate within a 0.3% trading band aroundthe U.S. dollar. The main components of the reference currency basket consist of the dollar, euro,yen, and Korean won, but the relative weights of each were not revealed. Since July 2005, there hasbeen little further appreciation of the yuan. Facilitate Globalization/Democracy. The UnitedStates could encourage even more globalization in China in order to foster internal change. Theforces of globalization and economic development in China are causing fundamental shifts in powerand interests. Irrespective of whether the rise of China's business and working class (as opposed topeasants and the military) will lead to an end to one-party rule, it is clear that the ruling ChineseCommunist Party (CCP) is being compelled to pay greater attention to business and worker interests. The CCP has attempted to coopt these interests by allowing businessmen to join the party and byseeking to broaden representation to include all segments of society. In addition to ceding space in its decision making process to industrial interests, the currentCCP leadership is coming into power with experience in the transformation of society that comesfrom development and modernization after opening to the outside world. The core of Chineseleadership has progressed from revolutionaries, to technocrats, to educated administrators andpoliticians. For these people, the country's dependence on international investment and trade for theeconomic growth needed to maintain the party's legitimacy has become an important considerationin policy making -- including security policy. Still, over the long term, whether this will induceBeijing to pursue policies of stability in security relationships and to open its society even furtherto international forces is yet to be determined. Globalization also is creating stresses with Chinese society that could spell trouble forBeijing. Widespread inequality in incomes both between the rich and poor in particular regions andthe gaping gulf in wealth and income between the coastal and inland provinces could cause unrest. Without the recent rapid economic growth, the rising ranks of China's unemployed would have beeneven larger. These unemployed in combination with a poor social safety net, dangerous workingconditions in many industries, corruption, and religious repression generated about 160 publicprotests per day in 2003. (78) Rapid economic growth in China may lead to more democracy,but it also could lead to civil disorder and repression. One policy question is how to encouragealternative power bases outside of the Chinese Communist Party and to sympathize with assortedpublic protests without inviting another Tiananmen Square type of crackdown. The United Statesis steering a fine line between partnership and pressure in supporting democratic forces inChina. (79) In thisendeavor, enlisting more support from Japan and South Korea could be useful, and the constant flowof information into China on democracy in Taiwan (and Hong Kong) can not help but have anaccumulating effect on perceptions across the Strait. Third Country Policies. The rise of China ishaving decided effects on the policies of Japan, South Korea, and Taiwan. Bilateral relationsbetween these states and China tend to divide into strata with economic relations charging aheadwhile security and political relations lag behind. The economic and financial activity, however, isaffecting security interests. In the six-party talks with North Korea, for example, the United Stateshas had to rely on the good offices of China with Pyongyang and to accommodate South Korea'spolicy goals, which in some areas, seem to coincide more with those of Beijing than those of theUnited States. Another example is the movement by East and Southeast Asian nations to organizeinto a free trade area (ASEAN + 3) that includes China but excludes the United States. This EastAsian Community based on a regional trade and financial system already is helping to induce Asiannations to invest in local and European currencies as reserves rather than the dollar. (80) This is not to say that U.S. influence is still not great in the region. China realizes thatforcing Asian states to choose between Beijing and Washington can be counterproductive --particularly those tied to the United States with security agreements. Since 2001, therefore, Chinesediplomacy has appeared to be less anti-American, (81) although Beijing continues to work toward a multipolar worldless dominated by the United States. It is apparent to Beijing that its national economic and militarypower is still too small to exercise much direct leverage over the United States and nationssupportive of U.S. efforts. But China appears to be taking advantage of its rising economic clout andgrowing trend toward regionalism to attempt to develop some mechanism to check what it considersto be U.S. hegemony. (82) This could be some sort of Asian community or more formal organization. One observer concludes that regionalism in Asia is less a matter of formally organizingseparate nations into something akin to the European Union or NATO than a matter of integratingcountries on the fringes of China into a vast China market. (83) Because of the widedisparity in types of government, levels of economic development, security orientation, and relationswith the United States, the most likely plurilateral institutions for Northeast Asia seem to befree-trade agreements with China at the center and deeper currency and other financial arrangementscooperation such as the Chiang Mai Initiative and Asian Bond Fund. A test of the growing influence of China appeared in the plans to hold the first East AsianSummit on December 14, 2005. One group of organizing countries led by Malaysia (withsympathies from China) wanted to limit the membership to ASEAN plus China, Japan, and SouthKorea (ASEAN + 3). Another group led by Singapore, Indonesia, Vietnam (with sympathies fromJapan) wanted to make the gathering more inclusive -- partly to dilute the influence of China. Ultimately, India, Australia, and New Zealand were added to the attendee list. The United Stateswas not even accorded observer status. After the summit, China appears to be retreating towardASEAN + 3 as the East Asian structure most conducive to and consistent with its regional goals inAsia. In either the East Asian Summit or ASEAN + 3, China appears to be maneuvering to positionitself at the center of any East Asian economic and political arrangement that might becomeinstitutionalized while nudging the United States to the periphery. (84) The growing influence of China is also being reflected in issues such as the lifting of theEuropean Union's arms embargo on China. Japan has sided with the United States in opposing thelifting of the embargo, but the apparent ease with which Beijing garnered initial support in theEuropean Union and the silence on the issue from South Korea seems to reflect the allure andmagnitude of the Chinese market -- in combination with other factors (such as European pique overthe Iraq War and their desire for a more multipolar world). With containment of communism no longer an imperative and the probability of aconventional military attack on homelands diminishing, attitudes in Japan and South Korea towardU.S. forces also are changing. In both countries, public support of the U.S. presence is still strongbut weakening. The basic alliances are still solid, but some are viewing the role of U.S. forces asless of a bulwark against outside attack and more as a backup safety measure just in case somecountry opts to take a hostile and disruptive action in the region. (85) A serious problem exists in Northeast Asia that diminishes the ability of the democratic statesin the region to counter Beijing's influence. The problem rests on the basic trust of Japan. In SouthKorea, in particular, there exists such an overhang of acrimony for Japan's 50-year occupation thathardly any bilateral activity seems to go well. Talks on a South Korea-Japan free trade agreementseem to be stalled (ostensibly because of agricultural issues), and a dispute over possession of anisland has again flared up. In calls for Japan's apologies, in interpreting history in Japanesetextbooks, and other such issues, Seoul sides squarely with Beijing. The United States could workmore with Japan and other countries in the region to resolve historical issues and dampen popularforces of nationalism in order to keep those nations from drifting toward an explosive enmity thatcould be avoided and could threaten U.S. interests. From one perspective, as long as the nationalisticand emotional outbreaks are kept under control, however, the United States actually could benefit. In this view, the more the Asian nations squabble among themselves, the more they tend to view the United States as a distant, third party whose history of relatively non-imperialistic policies can bewelcome. International economic relations are like streets -- they go both ways. While Beijing has beentrying to coopt its neighbors, particularly Taiwan, by enticing them into the Chinese economic andtrading network, Japan, South Korea, and Taiwan have effectively coopted China by making itdependent on their technology, financing, markets, and trade expertise. The net result of this mutualdependency is that all parties now have much to lose by any crisis -- be it military or financial -- thatwould disrupt economic and financial flows in the region. Economic activity abhors instability. The"electronic herd" (86) islikely to stampede at the first whiff of a serious military clash in Asia. Stock markets would fall;bond ratings would suffer; interest rates would rise; capital would flee; and a risk premium wouldbe applied to investments in the region. All four governments, therefore, seek stability ininternational relations. Without peace, it is difficult for economic engines to churn out wealth, andeven a rumor of war triggers penalties from international financial markets. It should not besurprising, therefore, for South Korea and Japan to seek to improve relations with North Korea orcarefully constrain their responses to incursions by Chinese naval ships into their exclusive economiczones. It also implies that sanctions or saber rattling that disrupt growing economic relations are notlikely to be welcomed in the region. In summary, protecting U.S. interests in security, prosperity, and value preservation can beconsistent with the economic rise of China. The key lies in channeling the burgeoning Chineseeconomic clout into paths consistent with U.S. goals in the region. In these efforts, the forces ofglobalization and economic interdependency among the economies of northeast Asia appear to alignroughly with U.S. interests in stability, economic freedom, and the promotion of democracy inChina. These same forces, however, have created the resources to fund military buildups and havecreated convenient targets for tension (e.g. anti-Japanese demonstrations in China) often unrelatedto political issues at hand. A key for U.S. policy seems to be to pursue policies with a sufficient doseof realism to account for the rising economic, political, and military power of China, while alsomaintaining long-term idealistic goals of fostering more representative government in Beijing andinducing countries to pursue peaceful relations, not only because of the U.S. military deterrent, butout of their own self interests. 

Summary: The economic rise of China and the growing network of trade and investment relations innortheast Asia are causing major changes in human, economic, political, and military interactionamong countries in the region. This is affecting U.S. relations with China, China's relations with itsneighbors, the calculus for war across the Taiwan Straits, and the basic interests and policies ofChina, Japan, Taiwan, and South Korea. These, in turn, affect U.S. strategy in Asia. China, forexample, has embarked on a "smile strategy" in which it is attempting to coopt the interests ofneighboring countries through trade and investment while putting forth a less threatening militaryface (to everyone but Taiwan). Under the rubric of the Six-Party Talks, the United States, China,Japan, Russia, and South Korea are cooperating to resolve the North Korean nuclear crisis. Taiwanese businesses have invested an estimated $70 to $100 billion in factories in coastal China. China relies on foreign invested enterprises for about half its imports and exports. For Taiwan,Japan, and South Korea, China has displaced the United States as their major trading partner. China interacts with Taiwan, Japan, and South Korea on four levels: human relations,economic and financial interaction, diplomatic and political intercourse, and military relations. Thetemperature of relations at each level ranges from cold to hot depending on the type of interactionand country or state being considered. At the human level the temperatures are mixed, at theeconomic level hot, at the diplomatic level cold for Taiwan to warm for South Korea, and at themilitary level, temperatures of interaction are cold. The implications of China's globalization and rise as a major economic power can be seenin its impact both on Beijing and on policy deliberations in Taipei, Tokyo, and Seoul. The ChineseCommunist leadership not only is having to cede space in its decision making process to industrialinterests but the leaders themselves are coming into power with experience in the transformation ofsociety that comes from development and modernization after opening to the outside world. Chinanow depends on international investment and trade for the economic growth needed to maintain theparty's legitimacy. For China's trading partners, dependency on the Chinese market means thatBeijing is looming larger in all aspects of policy making. While this is not likely to challenge U.S.security ties with Japan, South Korea, and Taiwan, it raises several policy issues. One is how to dealwith a modernizing and more powerful Chinese military financed by the growing Chinese economy. Another is how to explicitly incorporate into U.S. policy the greater weight that Beijing is beinggiven in policy deliberations in Tokyo and Seoul. A further policy issue is whether to take explicitmeasures to offset the rising economic clout of China and attempts by Beijing to create East Asianinstitutions with China at the center and the United States pushed to the periphery. A positive resultof the mutual trade and financial dependency that has developed in northeast Asia is that all partiesnow have much to lose by an international military crisis that would interrupt economic and financialflows in the region. All four governments, therefore, seek stability in international relations. Thisreport will be updated as circumstances warrant.