Tag Archive for: East Asia

A Covid-19 debt shock in Asia?

Even before the outbreak of Covid-19, the level of global debt was high by historic standards. According to the Institute of International Finance, by late 2019 global debt (including private and public debt) was more than US$250 trillion. Public debt, in particular, has increased everywhere since the global financial crisis of 2008.

International Monetary Fund calculations show that public debt ratios in almost 90% of advanced economies are higher than before 2008. On average, such ratios in emerging markets have increased to levels similar to those seen during the crises of the 1980s and 1990s. Public debt has also built up in low-income countries, two-fifths of which are at high risk of debt distress.

How much global debt has been added on the back of the Covid-19 health emergency? Focusing only on low-income and emerging economies, IMF managing director Kristalina Georgieva reckoned that US$2.5 trillion was a ‘very conservative, low-end estimate’ of their financing needs.

Where does Asia stand in all this? The two largest Asian economies, China and Japan, have some of the highest levels of debt in the world—at the end of 2017, Japan’s total debt stood at 395% of GDP and China’s at 254%. But there are some significant differences in their debt composition.

In Japan, debt is mainly public—approximately 237% of GDP in 2019—and is mostly held domestically. Around 70% of this debt is held by the Bank of Japan. Under normal conditions the combination of domestic–public debt holdings and very low interest rates considerably reduces the risk of default.

But will things change now? Japan’s emergency stimulus package announced in April 2020—a mix of cash handouts to households and firms, concessional loans and deferrals on tax and social security premiums—will widen the budget deficit to approximately 7.1% of GDP from 2.8% in 2019. This will bring the debt to around 252% of GDP. Japan’s already limited fiscal space has significantly narrowed as a result of the pandemic, pointing to some fiscal tightening and debt stabilisation when the economy gets onto a firm recovery path. This is especially necessary given Japan’s ageing population.

In China, on the other hand, debt is mainly corporate, with ramifications in the banking and shadow banking sectors. The rate at which it has grown in recent years is a cause of concern domestically as well as internationally. Capital controls, which were tightened in 2017 on the back of the renminbi’s weakening, are ensuring that individual and family savings remain in the country and continue to feed into the banking and the shadow banking sectors, keeping China’s debt sustainable.

The Covid-19 crisis and its impact on China’s economic activity—real GDP is expected to grow by 1–1.2% this year—created significant bottlenecks and increased the risk of financial instability. There are a number of areas of potential stress.

Small and medium-sized banks are exposed to the potential insolvency of small private firms and private borrowers. Larger banks face credit and liquidity risks due to their exposure to the heavily indebted real estate sector. The shadow banking sector, in which there are significant liquidity and maturity mismatches, is vulnerable to outflows that could be driven by savers withdrawing their money—either because they need their savings to face the economic crisis or because they panic amid falling equities prices and rising bond defaults.

China has responded to the crisis with an increase in welfare spending—such as unemployment insurance payments to support households—and temporary tax relief and deferral of tax payments for businesses in affected sectors and regions. Having significant fiscal space, China can extend its safety net to effectively mitigate the risk of personal and corporate bankruptcies, creating a buffer between banks and insolvent debtors.

Asia’s emerging economies show remarkable differences in levels of total debt. Some have entered the Covid-19 crisis with significant overall debt. Among the most indebted countries are Vietnam, India and Cambodia—with 189%, 126% and 116% of GDP, respectively—followed by the Philippines (99%), Pakistan (89%), Bangladesh (75%), Malaysia (73%) and Indonesia (69%).

The sharp decline in economic activity coupled with the risk of capital outflows—and a sudden increase in borrowing costs—could be particularly unsettling for countries with limited scope for fiscal policy measures, such as, for example, India, where state-owned banks are saddled with a significant stock of bad loans.

Other countries, like Indonesia and Thailand, have resorted to foreign currency interventions to mitigate the impact of capital outflows on their currencies. During the few weeks until the end of April, portfolio outflows from emerging markets amounted to approximately US$100 billion. Both Indonesia and Malaysia also implemented exceptional fiscal measures amounting to 1.8% and 2.8% of GDP, respectively.

Despite being at the epicentre of the Covid-19 outbreak, Asia (and East Asia in particular) has been more successful than Europe and the United States in containing the health emergency. Asian economies are due to recover earlier and faster. There has already been a rebound in Chinese exports (up 8.2% in April after a negative first quarter) due to stronger demand in Southeast Asia.

The international financial safety net has been extended in response to Covid-19, offering enough support for small and medium-sized economies to avoid them falling into liquidity or, worse, a solvency crisis on the back of the currency emergency. The IMF’s lending capacity has been stretched to US$1 trillion through the new arrangements to borrow and the bilateral borrowing arrangements. This is four times the amount that was deployed during the global financial crisis.

Concessional lending has tripled while the G20 agreed to suspend government loan repayments for developing countries. This makes the IMF the most significant provider of emergency funding in Asia while regional arrangements, such as the Chiang Mai Initiative Multilateralization, can provide further contributions. Of course, any IMF intervention needs to be set against the bigger global debt problem, while this is not the case for the CMIM. But the CMIM remains too small and untested.

Strong growth should eventually help Asia reduce its debt—at least the portion added as a result of the current crisis. Strengthening the CMIM and other regional financial arrangements, however, remains the best way to underpin financial stability.

The limits of China’s charm offensive

Over the past decade, China has taken an increasingly muscular approach to relations with East Asian countries. But in recent months—despite some hiccups in the South Pacific—it has surprised its neighbours with a charm offensive. What changed?

In terms of China’s behaviour in the region, quite a lot. In 2013, China unilaterally declared an air defence identification zone covering the East China Sea’s disputed Senkaku/Diaoyu Islands—a move that exacerbated tensions with Japan. A year later, China began to construct large artificial islands in disputed areas of the South China Sea. In 2016, China imposed sanctions on South Korea in response to the decision to allow the United States to deploy a missile-defence system there.

Now, however, such geostrategic bullying seems to be taking a backseat to diplomacy. Last month, Chinese President Xi Jinping welcomed Japanese Prime Minister Shinzo Abe to Beijing. Abe’s visit to China was the first for a Japanese leader in seven years, and Xi’s scheduled visit to Japan next year will be the first for a Chinese president in more than a decade.

Last week, Chinese Premier Li Keqiang headed to Singapore, where he signed an upgraded version of the China–Singapore free-trade agreement. He also hopes to sign and implement the Regional Comprehensive Economic Partnership, which China initiated several years ago to counter the now-defunct Trans-Pacific Partnership, next year (an overly ambitious target unlikely to be achieved, owing to the complexities of multi-party trade deals).

China’s new, less antagonistic approach does not reflect a change of heart or objectives on the part of its leaders, but rather a change in the regional geopolitical landscape. Over the past six months, the US has abandoned its four-decade-old policy of engagement with China, adopting a containment strategy instead. Facing escalating geopolitical competition with the US, China is scrambling to win friends in the region.

Although China’s charm offensive is very recent, its contours are already clear. The most prominent feature is trade. As the largest trading partner of numerous Asian countries, China will offer attractive trade terms to its neighbours, much as it has done with Singapore.

China’s new tactics also include more frequent high-level diplomatic engagement, focused on leading regional players, such as South Korea, Indonesia and Vietnam, in addition to Japan. Xi, for example, is scheduled to meet with Philippine president Rodrigo Duterte today. Through summits and other opportunities to convene senior officials, China will attempt to cultivate friendlier relations with its neighbours. To support these efforts, China’s propaganda machine has probably been instructed to tone down nationalist rhetoric and cut out content that might offend its neighbours.

Finally, China may temporarily restrain its assertion of territorial claims. For example, it is unlikely to turn the Scarborough Shoal, which it seized from the Philippines in 2012, into another artificial island in the foreseeable future. Likewise, it will probably avoid sending ships close to the Senkaku/Diaoyu Islands and antagonising Japan.

East Asian countries have so far responded positively to China’s new diplomacy, and they would undoubtedly welcome any respite from Chinese belligerence. But neither sweet talk nor trade deals will secure reliable allies for China, especially in a contest against the US.

Few in East Asia want to live in the shadow of a hegemonic China. The fear of that prospect has long underpinned America’s East Asian security architecture, which is based on bilateral alliances and forward deployment of the US military. And it sustains widespread support in East Asia for the US to act as a strategic counterweight in the region.

To be sure, most East Asian countries prefer not to choose a side outright. But if the US and China were to engage in direct strategic conflict—an increasingly likely prospect—it is the US that would gain the most support, especially from allies like Japan, South Korea and Vietnam. Malaysia and Singapore would probably also back the US.

If China wants to make reliable friends in its neighbourhood, it will have to make far greater concessions on security issues, especially territorial disputes. For example, a permanent settlement of claims concerning the Senkaku/Diaoyu Islands would go a long way towards convincing Japan that China does not pose a serious threat. Similarly, China’s acceptance of international arbitration of its claims in the South China Sea would assuage the fears of its Southeast Asian neighbors.

As it stands, there is no indication that Xi, who has pledged to ‘make China great again’, is so much as considering such concessions. But as long as China takes a purely tactical approach, it will reap purely tactical gains. When it comes to building friendships that can withstand strategic conflict with the US, those gains will not be nearly enough.

China, Japan and Trump’s America

The key strategic issue in East Asia is the rise of Chinese power. Some analysts believe that China will seek a form of hegemony in East Asia that will lead to conflict. Unlike Europe, East Asia never fully came to terms with the 1930s, and Cold War divisions subsequently limited reconciliation.

Now US President Donald Trump has launched a trade war with China and negotiations with Japan that take aim at Japan’s trade surplus with the United States. While the recent announcement of bilateral talks postpones Trump’s threat of auto tariffs against Japan, critics worry that Trump may push Japan closer to China, whose president, Xi Jinping, is scheduled to hold a summit with Prime Minister Shinzo Abe later this month.

The balance of power between Japan and China has shifted markedly in recent decades. In 2010, China’s GDP surpassed Japan’s as measured in dollars (though it remains far behind Japan in per capita terms). It is difficult to remember that a little over two decades ago, many Americans feared being overtaken by Japan, not China. Books predicted a Japanese-led Pacific bloc that would exclude the US, and even an eventual war with Japan. Instead, during President Bill Clinton’s administration, the US reaffirmed its security alliance with Japan at the same time that it accepted the rise of China and supported its admission to the World Trade Organization.

In the early 1990s, many observers believed that the US–Japan alliance would be discarded as a Cold War relic. Trade tensions were high. Senator Paul Tsongas campaigned for president in 1992 on the slogan, ‘The Cold War is over and Japan has won.’ The Clinton administration began with Japan-bashing, but in 1996, after a two years of negotiations, Clinton and Prime Minister Ryutaro Hashimoto issued a declaration that proclaimed the alliance to be the bedrock of stability for post–Cold War East Asia.

There was a deeper level of malaise, however, and although it was rarely expressed openly, it related to the Japanese concern that it would be marginalised as the US turned towards China. When I was involved in negotiating the reaffirmation of the alliance in the mid-1990s, my Japanese counterparts, seated across a table festooned with national flags, rarely discussed China formally. But later, over drinks, they would ask whether America would shift its focus from Japan to China as the latter grew in strength.

Such anxieties are not surprising: when two allies’ defence capacities are not symmetrical, the more dependent party is bound to worry more about the partnership. Over the years, some Japanese have argued that Japan should become a ‘normal’ country with a fuller panoply of military capabilities. Some experts have even suggested that Japan drop some of its anti-nuclear principles and develop nuclear weapons. But such measures would raise more problems than they would solve. Even if Japan took steps to become a ‘normal’ country (whatever that term may imply), it would still not equal the power of the US or China.

Today, Japan has a new set of concerns about American abandonment. Trump’s ‘America First’ orientation and protectionist policies pose a new risk to the alliance. Trump’s withdrawal from the Trans-Pacific Partnership was a blow to Japan. While Abe has skillfully played to Trump’s ego to deflect conflict, acute differences remain. The Trump administration’s imposition of steel and aluminium tariffs on national security grounds surprised Abe and has fuelled disquiet in Japan.

The Trump administration has also suggested that US allies in Asia should do more to defend themselves and openly questioned the value of forward-deployed US forces. Some analysts wonder whether Trump’s actions will force Japan to hedge its bets and edge towards China. But that is unlikely at this stage. While such options may be explored, they will remain limited, given Japanese concerns about Chinese domination. The US alliance remains the best option—unless Trump goes much further.

Thus far, the alliance remains remarkably strong. Abe reached out early to president-elect Trump, meeting him first at Trump Tower in New York and then during visits to Washington and Mar-a-Lago, Trump’s Florida residence. The Abe–Trump relationship allowed the Pentagon to maintain close cooperation on security matters. North Korea helped focus the alliance’s attention and provided an opportunity for Trump to assure Japan that the US was behind Japan ‘100%’.

Abe and Trump both supported the ‘maximum pressure’ strategy against North Korea, working hard to build international support for United Nations sanctions. Meanwhile, Japan announced a major new investment in ballistic-missile defence and cooperated in its joint development. On the other hand, Trump’s surprising reversal in attitude towards North Korean leader Kim Jong-un after their Singapore summit in June raised Japanese concerns about a US deal focusing on intercontinental missiles and ignoring the medium-range missiles that could reach Japan.

Trump’s rhetoric about burden-sharing has also raised concern. While Japan’s defence expenditure is little above 1% of GDP, it contributes significant host-country support. The US Department of Defense estimates suggest that the Japanese government pays roughly 75% of the cost of supporting US forces in Japan. This year alone, the Japanese government budgeted ¥197 billion (US$1.7 billion) for cost-sharing, ¥226 billion (US$2 billion) for the realignment of US forces, and ¥266 billion (US$2.3 billion) in various types of community support, among other alliance-related expenditures.

As the Clinton administration recognised a quarter-century ago, China’s rise created a three-country balance of power in East Asia. If the US and Japan maintain their alliance, they can shape the environment that China faces and help moderate its rising power. But that will depend on the Trump administration.

The plausibility of multiple alternative scenarios

In their recent ASPI paper, Paul Dibb and Richard Brabin-Smith suggested that government advisers need to ‘revisit the question of capability and warning time’ based on the levels of military force Australia could face at short notice, particularly from China. The Pentagon’s 2017 report to Congress, Military and security developments involving the People’s Republic of China, provides a good insight into the issues Australian officials should be contemplating.

The prospect of a conventional war between China and the US is frightening enough, but the thought of Australia confronting China alone brings on despair. That this might require a ‘capacity to engage in high-intensity conflict in our own defence—in a way that we haven’t previously had to consider’ is an understatement.

Strategic policy is plagued by the ‘plausibility of multiple alternative scenarios’ problem. Whether deriving foreign policy objectives, shaping defence capability investment, establishing force readiness levels or deploying combat forces, the government has to commit to the notion that some future scenarios are more plausible than others.

The 1987 Defence White Paper determined that it ‘is possible to indicate the principal contingencies that must shape Australia’s defence planning’. In particular, ‘force structure planning’ should ensure Australia’s capacity to respond to those contingencies. The three levels of ‘credible’ contingencies—low level, escalated low level and more substantial—also informed judgements about logistics, sustainment, basing and industry policy. That led to plausible scenarios with an emphasis on northern Australia. The intellectual power of the levels of contingency was generated by the concept of warning time.

However, the 1987 white paper had not anticipated the end of the Cold War, which reconfigured fundamentally the global strategic situation. Cold War superpower competition was a zero-sum game and Australia could be confident of US support in the remote possibility of a Soviet threat. That left Australian planners to deal with credible lower-level contingencies.

But for warning time, the end of the Cold War meant that ‘the concept and its systematic force structure guidance … disappeared from our defence white papers’ and ‘the 1987 rationale disappeared along with the calculations’. The 1994 white paper observed that ‘previously, our defence planning has been able to assume a degree of predictability in our strategic circumstances’, and that no longer existed.

China would need to have a very serious dispute with Australia to take military action, a dispute that couldn’t be resolved without military action. China would need to have a clear and crucial strategic or national objective. Such a dispute isn’t currently in prospect, but the quirks of international politics don’t exclude the rapid appearance of one. The recent differences over trade and climate issues between allies is evidence of how quickly the ground can shift.

In the event of a dispute so serious that it made military aggression unavoidable, the most plausible scenario is one where China immediately threatened or targeted cities or infrastructure in southeastern Australia. Even if an attack on Australia was a diversion in the context of a wider East Asian war, Chinese forces would most likely target strategically significant assets in the southeast. A major assault in the north of Australia would make little strategic sense.

The further out into the future this scenario is projected, the more difficult becomes any plausible effective Australian response. China is growing its blue-water navy and will continue to do so, providing it with significant reach and stand-off capability. Successful defence of the southeast of Australia in decades to come seems progressively more improbable.

Against an adversary like China, the notion of warning time and the associated concept of an expansion base for the ADF seem obsolete. As the Pentagon report emphasises, China’s military capabilities are already growing at rate that Australia will never be able to match. No matter how much warning time Australia had of an attack, it wouldn’t be able to make adjustments that would materially alter the increasing deficit in relative military power of the two states.

On the contrary. Australia will progressively fall further behind China. China’s defence budget is predicted to reach US$260 billion by 2020, compared to Australia’s 2017–18 defence budget of US$25.6 billion. In addition, China’s massive investment in science and technology is geared to producing a military force that is not just large, but at the absolute cutting edge of technology. China is among the world leaders in robotics, artificial intelligence and space technology, and has accorded high priority to the application of science to capability.

That doesn’t mean that the ADF shouldn’t be as modern, capable and prepared as Australia can afford. It does mean that no matter how much or how little warning time Australia has to plan, within a decade or so no expansion base will be sufficient to defend effectively vital Australian assets from a concerted Chinese assault. The defence planning and strategic concepts of the Cold War era have little relevance today.

On the one hand, of course, no scenario is plausible where, within current planning horizons, the ADF would confront China except in company with the US and in the context of the alliance. On the other, the strategic reality is that the future of Australia is entwined with China’s and needs to be part of it. Responding to China will not be primarily a defence matter. It can only be a matter for foreign policy and diplomacy.

Towards China’s A2AD 2.0

China’s military modernisation remains a key concern for the US and its allies. Crucial in that regard has been China’s development of forces geared towards preventing uncontested access to its air and maritime approaches by potential adversaries. Such ‘anti-access and area denial’ (A2AD) capabilities are designed either to prevent an adversary’s access to a particular region (anti-access) or to contest its freedom of movement within that theatre (area denial).

The US isn’t standing still. It faces a more challenging task in projecting power into the western Pacific than China does in defending its near and middle seas. Defence is always easier than offence.  The US is counting on its ‘third offset strategy’—the development of next-generation technologies—to preserve its military–technological edge in this contest. Yet the third offset may be little more than wishful thinking in any practical sense. And it would be risky to assume that the US will win this race, because several factors may undermine its ability to respond to Chinese developments.

The US faces the dilemma of whether to direct investment towards modernising its forces or towards ensuring the sustainment and readiness of existing forces. That problem is acute because, as a global superpower, the US faces immediate global challenges. China doesn’t, so it can focus its investment on future East Asia contingencies, including developing more effective A2AD.

US military readiness and combat sustainability are very poor as a result of 10 years of temporary funding arrangements under ‘continuing resolutions’. Without stable budgets, US military leaders can’t pursue adequate defence planning to ensure a balance between modernisation, sustainment, readiness and force development. Recent US Navy collisions caused by atrophying seamanship skills, a severe shortage of fighter pilots in the US Air Force, and poor readiness of carrier air wing F/A-18s highlight the problem. There’s also a worrying lack of anti-submarine warfare (ASW) skills and capability in the US Navy.

The latest US defence budget of $700 billion has been passed by the House of Representatives. However, it blasts through ‘sequestration’ spending caps by $72 billion. It will likely be passed by the Senate and signed into law by President Trump, but then the funding will be cut automatically by sequestration unless spending caps are lifted, which is unlikely. With this dismal state of affairs in mind, future projections of US defence spending aren’t good.

The main problem is that budget instability will continue to undermine the US’s ability to maintain adequate readiness while funding modernisation. It simply can’t do both. Nor can it boost the size of its forces to respond effectively to a range of threats around the globe. The Trump administration’s plan to increase the US Navy’s fleet to 355 ships represents an unachievable dream that does little to respond to the immediate growth of China’s navy in both size and capability. As US forces ‘age out’, China will likely continue to introduce new capabilities that will accentuate the perception of a closing capability gap.

China is steaming ahead with its military modernisation program, which is based on the informationisation (that is, developing an integrated joint warfare capability) of the PLA, while continuing to extend its ability to counter intervention through better A2AD.

The US–China Economic and Security Review Commission recently released its 2017 report to Congress highlighting some key capability areas to watch, including research and development into hypersonic weapons such as the DZ-ZF hypersonic glide vehicle, ‘scramjet’-based hypersonic anti-ship cruise missiles and directed-energy weapons. China has also made significant improvements to its submarine quieting and undersea warfare capabilities as part of its ‘undersea great wall’, and is placing more emphasis on long-range anti-air capabilities targeted against critical US and allied ‘combat enabler’ platforms like tanker and airborne early warning aircraft. New capabilities being developed include a new H-20 bomber that would expand China’s ability to undertake long-range anti-ship and land-strike roles. On the horizon, China is investing heavily in breakthrough fields such as quantum physics, including cryptography, sensors, computers and radars, as well as researching AI and battlespace robotics.

Together, these advances will significantly strengthen China’s A2AD capability and envelope, and make it more difficult for US forces to intervene in a future crisis in East Asia. China is just getting to grips with carrier operations and is continuing to face challenges in gaining experience in joint warfighting and undertaking expeditionary operations. And the US still has an advantage in ASW (though that’s being narrowed) and underway replenishment. But it’s clear that China is determined to move from catching up to leaping ahead in key technology areas.

In this scenario, China could leapfrog US capabilities as it invests in the new A2AD-type capabilities—A2AD 2.0. That could begin to tip the local military advantage in Beijing’s direction.

Growth without industrialisation?

Despite low world prices for the commodities on which they tend to depend, many of the world’s poorest economies have been doing well. Sub-Saharan Africa’s economic growth has slowed precipitously since 2015, but this reflects specific problems in three of its largest economies (Nigeria, Angola and South Africa). Ethiopia, Côte d’Ivoire, Tanzania, Senegal, Burkina Faso and Rwanda are all projected to achieve growth of 6% or higher this year. In Asia, the same is true of India, Myanmar, Bangladesh, Lao PDR, Cambodia and Vietnam.

This is all good news, but it is also puzzling. Developing economies that manage to grow rapidly on a sustained basis without relying on natural-resource booms—as most of these countries have for a decade or more—typically do so through export-oriented industrialisation. But few of these countries are experiencing much industrialisation. The share of manufacturing in low-income Sub-Saharan countries is broadly stagnant—and in some cases declining. And despite much talk about ‘Make in India’, one of Prime Minister Narendra Modi’s catchphrases, the country shows little indication of rapid industrialisation.

Manufacturing became a powerful escalator of economic development for low-income countries for three reasons. First, it was relatively easy to absorb technology from abroad and generate high-productivity jobs. Second, manufacturing jobs did not require much skill: farmers could be turned into production workers in factories with little investment in additional training. And, third, manufacturing demand was not constrained by low domestic incomes: production could expand virtually without limit, through exports.

But things have been changing. It is now well documented that manufacturing has become increasingly skill-intensive in recent decades. Along with globalisation, this has made it very difficult for newcomers to break into world markets for manufacturing in a big way and replicate the experience of Asia’s manufacturing superstars. Except for a handful of exporters, developing economies have been experiencing premature deindustrialisation. It seems as if the escalator has been taken away from the lagging countries.

What, then, are we to make of the recent boom in some of the world’s poorest countries? Have these countries a discovered a new growth model?

In recent research, Xinshen Diao of the International Food Policy Research Institute, Margaret McMillan of Tufts University, and I have looked at the growth patterns among this new crop of high-performing countries. Our focus is on the patterns of structural change these countries have experienced. We document a couple of paradoxical findings.

First, growth-promoting structural change has been significant in the recent experience of low-income countries such as Ethiopia, Malawi, Senegal and Tanzania, despite the absence of industrialisation. Labour has been moving from low-productivity agricultural activities to higher-productivity activities, but the latter are mostly services rather than manufacturing.

Second, rapid structural change in these countries has come at the expense of mostly negative labour productivity growth within non-agricultural sectors. In other words, even though the services that absorbed new employment exhibited relatively high productivity early on, their edge diminished as they expanded. This pattern contrasts sharply with the classic East Asian growth experience (such as in South Korea and China), in which structural change and gains in non-agricultural labour productivity both contributed strongly to overall growth.

The difference seems to be explained by the fact that the expansion of urban, modern sectors in recent high-growth episodes is driven by domestic demand rather than export-oriented industrialisation. In particular, the African model appears to be underpinned by positive aggregate demand shocks generated either by transfers from abroad or by productivity growth in agriculture.

In Ethiopia, for example, public investments in irrigation, transport and power have produced a significant increase in agricultural productivity and incomes. This results in growth-promoting structural change, as increased demand spills over to non-agricultural sectors. But non-agricultural labour productivity is driven down as a by-product, as returns to capital diminish and less productive firms are drawn in.

This is not to downplay the significance of rapid productivity growth in agriculture, the archetypal traditional sector. Our research suggests that agriculture has played a key role in Africa not only on its own account, but also as a driver of growth-increasing structural change. Diversification into non-traditional products and adoption of new production techniques can transform agriculture into a quasi-modern activity.

But there are limits to how far this process can carry the economy. In part because of low income elasticity of demand for agricultural products, outflows of labour from agriculture are an inevitable outcome during the process of development. The labour that is released must be absorbed in modern activities. And if productivity is not growing in these modern sectors, economy-wide growth ultimately will stall. The contribution that the structural-change component can make is necessarily self-limiting if the modern sector does not experience rapid productivity growth on its own.

Low-income African countries can sustain moderate rates of productivity growth into the future, on the back of steady improvements in human capital and governance. Continued convergence with rich-country income levels seems achievable. But the evidence suggests that the growth rates brought about recently by rapid structural change are exceptional and may not last.

After the next Korean war

There are few strategic policy issues as intractable as those appending to North Korea. A war would result in millions of Korean casualties and in the destruction of essential infrastructure, industrial capacity and urban habitation on the Korean peninsula. In such a conflict, the US would inevitably prove victorious and the level of destruction visited on North and South Korea would probably be catastrophic. The strategic impact of the conflict would be felt well beyond Korea and could seriously destabilise East Asia.

Viable solutions to the impasse over the denuclearisation of the DPRK have been elusive. A diplomatic solution acceptable to both sides seems unreachable. A pre-emptive strike by either the US on North Korea or by the DPRK on US forces or the US homeland, resulting in a major war on the peninsula, could produce an even more dangerous situation in East Asia than the current stand-off.

At absolute worst, China, and possibly Russia, wouldn’t remain neutral during a conflict—raising the possibility of an East Asia–wide war. But even if both stood by, in a postwar situation it’s unlikely that China would then tolerate US occupation of the Korean peninsula; nor would Russia be comfortable with US troops on its Asian border. The US would have objections to China or Russia assuming control of DPRK territory. After the conflict, the Republic of Korea would likely be in no position to take over control of the north. Control of the peninsula would become a very important and challenging matter.

A Korean war can be expected to be at least as catastrophic as any contemporary conflict. Both sides would deploy sizeable and capable regular military forces. Apart from widespread destruction, massive migration of Koreans fleeing the conflict zone could be expected, heading to Japan, China, Taiwan, the Philippines and perhaps Australia. Ten million people reside in Seoul, 51 million in the ROK and 25 million in the DPRK.

The ROK is a modern, advanced trading economy. Rebuilding the social and economic infrastructure on the peninsula after a DPRK attack would be a massive financial burden and an enormous organisational task that neither the US, the EU nor Japan would be prepared or able to take on. Providing peacekeeping troops or civil administration would prove enormously problematic for the UN—given the Security Council vetoes of China and Russia—and violence might become entrenched. The postwar conditions on the Korean peninsula could be an ongoing security problem for decades.

The broader strategic significance of the Korean peninsula stands out. China and the US would both have a deep strategic interest in dominating the peninsula. The Tsushima Strait at the entrance to the Sea of Japan between Bosan and Fukuoka is a mere 200 kilometres wide. Possession of the peninsula would potentially provide China with total security for naval operations in the Yellow Sea and easy access to dominate the Sea of Japan and the East China Sea. Together, China and Russia would have an effective chokehold on the Sea of Japan. Chinese aircraft based on the peninsula would threaten Japan directly. Conversely, China would strongly resist any US presence on the peninsula because that would imperil core Chinese strategic ambitions in maritime East Asia.

In the wake of a major war on the peninsula, the strategic competition between the US and China in East Asia would intensify dangerously, Japan’s security would be eroded, and contention over islands in China’s littoral seas would increase.

Australia’s key security and economic interests would be under even more threat in this post-conflict scenario than they are now from a North Korean regime with a relatively limited strategic nuclear capability. Australia poses no serious military threat to the DPRK at present, and the North Korean regime, which is obsessively focused on the US as the existential threat, poses no military threat to Australia. Currently, the ROK ranks fourth among our bilateral trading partners. In 2015–16, Australia exported $19.7 billion in goods and services to the ROK, including substantial amounts of coal, iron ore, aluminium, beef, sugar, medicaments and wheat. The adverse economic impact of war on the peninsula would be significant.

Prime Minister Turnbull has indicated that Australia would invoke ANZUS were the DPRK to attack the US. That would primarily be empty symbolism, given Australia’s inability to affect the outcome of any conflict. It would also represent a failure—or an absence—of Australian strategic policy. Putting aside what Australia’s position would be if the US acted pre-emptively, it seems self-evident that Australia’s primary interest is in avoiding a conflict.

The chance of a degree of disruption, uncertainty and strategic danger spreading beyond the conflict zone raises questions of planning and preparedness for the Australian government. A post-conflict situation that would engender far higher tensions and confrontation between China, Russia and the US must be factored into Australia’s strategic policy decisions. The government must explain where it’s prepared to take the nation in support of the US.

Australia needs a comprehensive and transparent public and parliamentary debate in which the government sets out its view of Australia’s interests, the threats to those interests, Australia’s capacity to manage or influence those risks and the preferred end state. The Australian public must understand what’s at stake.

The government needs to reassure the public that it has a comprehension of the strategic issues in East Asia—and how a new Korean war might engage the interests of the major powers—beyond the emblematic invoking of ANZUS. It needs a strategic policy.

East Asia 2036

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Earlier this year PwC reported it had identified ‘the equivalent of US$250 billion in projects… [which have] been built already, recently started construction or have been agreed on and signed’ related to China’s One Belt One Road (OBOR) initiative. OBOR is a massive undertaking with two fundamental components. The maritime ‘road’ strategy is focused on developing ports in the Indian Ocean, the coast of Africa and the Mediterranean.  The ‘belt’ involves investment in infrastructure cooperation in a zone that stretches from Xinjiang (the north-western part of China) to the Baltic Sea.  These activities will have consequences for East Asia that go beyond trade and will shape the strategic environment in coming decades.

The scale of the initiative is impressive. A European Parliament report estimated that it could involve, ‘an area that covers 55% of world GNP, 70% of global population, and 75% of known energy reserves’. The vision and framework for the initiative were released by the Chinese Government in March 2015 and it emphasises cooperation between China and the countries involved in ‘policy coordination, facilities connectivity, unimpeded trade, financial integration and people-to-people bonds’. If even partially successful, China will eventually sit at one end of ‘a massive trade network reaching from often neglected central Asia to Central Europe’. As of May 2016 China held US$3.19 trillion in foreign exchange reserves and US$746 billion in its sovereign wealth fund. With US$890 billion worth of deals officially in train, ‘the massive trade and investment effects across Eurasia could well reshape a significant part of the global economy’.

But the sheer size of China’s ambition has led to arguments for caution about its prospects. Optimists tend to ‘underestimate the obstacles for China’s OBOR initiative both inside and outside of China’ while there’s been an ‘exaggerated concern on the part of those fearing a more powerful China’. Some reports indicate investors are ‘skeptical about whether the financing will be available’. Nevertheless despite widespread recognition of the ‘daunting challenges’ OBOR faces, China’s progress to date has impressed.

Apart from the possible economic benefits from the investment in OBOR, significant success would see China reap strategic and security benefits. OBOR can be seen as a response to the US pivot to Asia and more directly as ‘addressing security challenges on its western periphery as well as energy security issues’. Not least is the enormous strategic and operational depth that both China and Russia will gain from having secure rear areas. Russia would benefit by being able to concentrate on NATO and Europe and China could exploit if it came to fighting a war of attrition with the US alliance in East Asia.

And China and Russia are growing closer. To understand the future East Asian environment, it’s important to understand the strategic implications of developments between Sevastopol on the Black Sea and Zhanjiang on the South China Sea. On 24 July Chinese Foreign Minister Wang Yi identified Russia as China’s most important partner, adding ‘China and Russia are developing the comprehensive strategic coordination as a strategic principle, rather than any expediency’. At the same meeting Sergei Lavrov said cooperation with China is Russia’s major foreign policy orientation’. Putin has spoken of ‘a comprehensive partnership and strategic collaboration’ with China.

The slow and cautious rapprochement between Russia and China has been gathering pace since the 1990s. OBOR represents common ground given their shared ambition to gain more international influence and to limit the influence of the US at the global and regional level. Their preference for a multipolar world order, ‘where the actions of the great powers are determined by their national interests and the maintenance of their sovereignty’ rather than universal norms will be progressed by OBOR. Russians acknowledge that OBOR is complementary to their own Eurasian Economic Union (EEU) initiative. Russia and China have signed major energy, resource and transport investment agreements recently.  OBOR is ‘is both an exercise in diplomacy as well as an attempt to alter the way one looks at the global economy and the balance of power’.

China will also strengthen its global political and economic influence and build its ability to exercise soft power and pursue foreign policy goals. Involvement in OBOR by numerous multinational bodies, including the Shanghai Cooperation Organisation, ASEAN, the Asian Infrastructure Investment Bank, the European Investment Bank, and China’s membership in the European Bank for Reconstruction and Development will further embed its influence in international affairs.

Some commentators are recognising that China might be providing a viable alternative to the liberal international world order. China is making clear that there are no political preconditions for involvement in OBOR. Unlike many post-World War 2 international bodies that impose conditions around free market reforms and the adoption of liberal democratic practices, China offers cooperation without interference. For many commentators the challenge to what’s described as the Western hegemony is already under unparalleled pressure which OBOR can only increase.

The whole strategic game in East and Central Asia and even Europe may have changed in 20 years’ time and in large measure because of OBOR. The grand Chinese plan will face many challenges, problems and obstructions and, while it may fall short, it’ll inevitably have an impact. Even if doesn’t deliver everything it promises, it’s likely to irrevocably change the strategic landscape, and we need to recognise and plan for it.

Hostage crisis wasn’t Japan’s 9/11

DirectionThe dramatic hostage crisis in Syria ended tragically with the execution of two Japanese hostages and a Jordanian pilot by ISIS militants. Kunihiko Miyake, a former Japanese diplomat, described the crisis as a ‘9/11 for Japan’, a sign that the country must face the ‘harsh reality of the world.’ Miyake, along with many Western and Chinese analysts, believes the incident could be a catalyst for Prime Minister Shinzō Abe’s security normalisation agenda. But the recent hostage situation is unlikely to be a gamechanger for Japan’s security policy.

While the hostage crisis held global media attention, the public reaction in Japan is a complex consideration. The Japanese left was most actively involved in the issue organising small-scale protests demanding the ransom be paid in exchange for the hostages’ safety, and using the hostage crisis to highlight the challenges of ‘normalisation’. The country’s major left-leaning newspaper, Asahi Shimbun, published an editorial that described Japan’s tradition of pacifism and noninvolvement as the ‘best defense against terrorism’. The left wing contends that it’s Abe’s active security policy in the Middle East that’s led to the hostage crisis. Read more