For pension funds, the investment implications of China's holding U.S. military personnel from the damaged U.S. surveillance aircraft for almost two weeks before releasing them seem clear. Internal and external tensions and strains mean great political risks ahead for China and considerable short-term fluctuations in asset valuations. Only pension funds that have the fortitude to bear these swings and can invest for China's long-term potential should consider risking their assets in the country.
The incident needs to be understood in the context of China's internal and external politics. China is an emerging economic superpower, driven by an enormous internal market, abundant human capital and great (and soon to be greater) trading potential. China also is a country susceptible to serious instability as its Communist Party leadership attempts to balance a totalitarian political system with an increasingly market-based economic model. The upside potential is tremendous; the downside risk is frightening.
China's immediate future depends largely on its success in managing three processes - relations with the United States, entry in the World Trade Organization, and replacing its elderly leaders. All three will mean more tensions externally and internally. By holding the spy plane crew for 11 days, the regime mobilized popular support in a show of patriotism and Chinese nationalism, diminishing internal instability. But in the process, China's relations with the rest of the world, and particularly the United States, will suffer. Chinese leaders understand the tradeoffs and likely will accept the internal consequences to moderate their conflict with the United States in order to advance Chinese global interests. But tensions between the United States and China are here to stay.
China wants the United States out of Asia, and it wants to be recognized as an East Asian superpower (a notion deeply unsettling to Taiwan and Japan). China increasingly is becoming less tolerant of what it sees as U.S. violations of its sovereignty: the aircraft carriers the United States sent to the Taiwan Straits in 1996; the U.S. bombing of the Chinese embassy in Belgrade in 1999; the defection of a high-level Chinese military officer to the United States in 2000; and the planned construction of a missile shield in the United States. China's ambitions and resentments will increase the level of global tension.
China's impending WTO accession will deepen its integration into the world economy, but it also likely will trigger a rash of trade disputes with the United States, including China's paying agricultural subsidies, "dumping" products below-market prices, recognizing intellectual property rights, as well as China's hidden trade barriers.
China's WTO entry also carries significant risks to China's domestic stability. To be sure, foreign direct investment will rise, business will become more transparent, and the culture of guanxi (connections) will yield to a more entrepreneur-friendly business climate. But to comply with WTO rules, China has promised to bring down tariffs and import quotas, eradicate export subsidies and open its service industries - notably, banking and insurance - to foreign participation. These are daunting tasks that will require massive reforms of the Chinese bureaucracy, judiciary and public sector.
To prepare state-owned companies for competition, the government has said it will continue its program of massive layoffs - as many as 20% of public-sector workers over the next five years. As the ranks of the unemployed swell, the Communist Party will have to cope with the rise of widespread dismay in the cities.
WTO rules also will wreak havoc on rural China, home to 900 million people. As agricultural subsidies and import barriers are reduced, the rural sector will suffer. According to some, there were 100,000 strikes, protests and demonstrations in rural China in 2000. Rural unrest and urban migration likely will increase in the coming years.
Yet another risk to Chinese stability comes from leadership succession. President Jiang Zemin appears to have groomed Hu Jintao, vice president and chairman of the Central Military Commission, for the top job. It appears that Hu, who is no liberal, will assume power in late 2002, but Jiang has vowed to stay on as head of the military. Threats to a smooth succession likely will arise from disputes within the Communist Party over responses to the growing economic and political turmoil.
Even with the spy plane crew returned, U.S.-China relations will calm down. But the tension probably will be reignited. The U.S. had better be ready to deal with a resurgent, demanding and potentially unstable China.
Marvin Zonis is professor of international political economy at the Graduate School of Business at the University of Chicago. Dan Lefkovitz is director of country analysis at Marvin Zonis + Associates, Inc., Chicago, a political-risk consulting firm, where Mr. Zonis is chairman.
