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.