China’s industrial overcapacity and economic and social difficulties can be an advantage for India, but for that the Modi government will have to change the thrust of its foreign policy
Future historians are likely to chalk up Chinese Foreign minister Wang Yi’s visit to India this week as one of the most fateful diplomatic overtures of the post-Cold War decades, for its outcome may decide not only the future course of relations between China and India, but very possibly spell the difference between peace and war in the South China sea.
Wang Yi has come with two very specific purposes. The first is to correct the impression that China was the prime mover behind India’s failure to become a member of the Nuclear Suppliers’ Group last month. The second, and far more important, is to get a precise idea of where India stands in the developing confrontation between it and the US in the South China sea. He began his visit with an explicit statement in Goa on Friday that the prevalent impression in Goa about India’s failed bid to join the NSG was wrong. This was intended to clear the decks for obtaining a clear cut response on how India views the International Tribunal’s condemnation of its encroachment on large parts of the South China Sea.
Beijing clearly feels it needs this clarification because while India has supported the Tribunal’s verdict that China is bound by the UN convention on the Law of the Sea, it has also strongly advocated that the dispute should be settled by the countries adjoining the sea through negotiation. Negotiation means accommodation, so this enabled Beijing to include India among the two score countries that had backed its position.
But western governments, and the Indian media, had taken the Indian statement as an endorsement of the Western view that the UNCLOS means not only freedom of navigation for commercial vessels but also warships. Coming in the wake of Prime Minister Narendra Modi’s decision to send four Indian warships to join a US-Japan Task force sailing through the South China Sea four months later, and with the next BRICS summit only two months away, it had become imperative for China to clear its doubts.
Why is China attaching so much importance to India’s position on this issue? To most Indian analysts, China’s single and unswerving aim since the Bandung honeymoon ended in 1962 has been to keep India in line by periodically creating tension on the Himalayan border, building Pakistan up to foil its regional hegemonic ambitions, and isolate India within South Asia. So they have never believed that China is willing to settle the issues of the past in order to cooperate with India in the future, and have viewed its recent overtures as traps designed to hoodwink India into making concessions that it cannot later retract.
This somewhat paranoid mind-set has been enhanced by the aura of infallibility that China’s economic success has bestowed upon its leaders. We have watched Chinese per capita income grow from parity with India in 1981, to four times greater in 2014. We have seen it change from a closed economy to the world’s largest trading nation – with exports of $2.1 trillion last year – in just 40 years.
With envy and disbelief, we have watched it begin from scratch in 2004 and build a 19,000 km bullet train network that carries 2,000 pairs of trains every day, in barely 11 years. We have seen it turn Fiery Cross reef in the South China Sea into an airstrip in barely six months using extremely powerful dredgers designed and built by its own engineers. And we don’t have the faintest idea how they have done it. So what do we have to offer that China can possibly want?
The answer is breathtakingly simple: Like the US, China too wants to harness India’s soft power. But the goal for which it wishes to do so is the avoidance of war. China owes everything it has achieved to world trade; trade flourishes only when there is peace and is, therefore, the first casualty of war. China, thus, has a vital stake – perhaps the largest of any country in the world – in the maintenance of world peace.
This view of its foreign policy goals is in stark contrast to the one assiduously highlighted by western governments and media. According to them China is a monolithic colossus with an awareness of its nationhood that stretches back to the 3rd century BCE, that is bent upon using its immense economic power to recapture its position as the ‘middle kingdom’. Its nine-dash line, its claim of political hegemony over the South China Sea, and its use of massive investments in Africa, central and South Asia to establish its economic hegemony over a widening arc of the world are all driven by this ambition.
China’s actual foreign policy is an amalgam of both motivations. Its leaders, from Deng Xiaoping to Xi Jinping, have all shared this vision of their country. They are fully aware that its rising economic power poses a challenge to the US’s global hegemony, and particularly to its hegemony over the eastern Pacific. They believe that a shift of power from the US to China in this region has begun and will continue so long as the Chinese economy continues to grow at a much faster rate than the American. Their overriding concern is that this shift should not go out of control and spill over into war.
This duality is clearly visible in their pronouncements on the purpose of the airstrip on Fiery Cross reef in the Spratly islands. While it is clearly intended to create a basis for Beijing’s territorial claims in the disputed waters, and be used as a military airfield when necessary, Beijing continues to insist that its main purpose is to serve as a base for communications and search and rescue operations that will enhance he security of mercantile shipping in the area.
The ambivalence in Chinese statements also springs from the fact that the Communist Party is using nationalism to shore up its mandate from Heaven in the face of rising corruption, rural and, more recently middle, class unrest at home and extreme inequalities in income, while attempting to build a rule bound, multi-polar world to facilitate a gradual and peaceful shift of power in the eastern Pacific. The US and its allies have chosen to emphasise the first. China would like India’s support in achieving the second.
Till 2008, the conflict between the two goals remained muted because the rapid growth in its exports was taking place in an expanding global economy. This limited the displacement of existing producers in other countries. But the onset of global recession in 2008 and a sharp slowdown in its own growth rate in 2012, has made China dump more and more of its surplus products on the world market in its effort to keep its factories and workers employed. The sentiment that it is not playing by the rules and must be ‘contained’ has therefore grown rapidly stronger.
Till 2011 China’s quest for a strategic relationship with India had stemmed almost entirely from a desire to put brakes upon the US’s increasing predilection for war as its preferred tool of foreign policy. But when its economy took a sharp turn for the worse in 2012, it found a new, even more urgent, reason: with its huge deficit in infrastructure and its still reasonably high growth rate, India was the only country left that could absorb enough of China’s output of machinery steel and cement to substantially ease its crisis of overcapacity.
In July 2012, weeks before he left office, Premier Wen Jiabao was asked by a Chinese reporter whether the government intended to check the slowdown in growth by applying another fiscal stimulus to the economy. Wen’s reply was that he would not do so under any circumstances because ‘the economy was already suffering from excess capacity in 21 sectors’.
Wen was understating the magnitude of the looming crisis. For by then, a two-year fiscal stimulus programme begun in 2009 had run completely out of control and led to vast, mostly useless, additions of capacity. Against 4.3 trillion Yuan ($586 billion) to be spent over 24 months, central ministries and provincial governments had managed to commit 12 trillion Yuan in just 14 months. 80% of this money had gone into infrastructure, basic industries and real estate and created a bubble, the likes of which the world had never seen.
Western economists have likened China’s predicament to Japan’s in 1990, and South Korea’s at the time of the Asian financial crash in 1997. Chinese growth, they predict, will remain low for many years to come, till gradually rising demand and the retirement of obsolete and poorly managed enterprises, eliminates the excess capacity built up in the past.
This comfortable prediction ignores the trauma of transition and the options open to China if it wants to lessen it. In China’s case, this will be far more severe than it was in Japan and South Korea. This is because while those were basically market economies with healthy doses of state guidance, China’s is still fundamentally a command economy. When centralised planning was wound up in the mid-1980s, the power to invest passed into the hands of 60,000 township administrations, and around 15,000 investing authorities created by the provincial governments at three higher levels of local government.
In all of these, investment decisions are not dictated by the still weak signals from the market, but by the ambitions of party bureaucrats. The result has been huge surges of over-investment, followed by equally precipitate crashes that Beijing has done its best to pretend were just ‘soft landings’.
The steel industry is a good example. Despite the global recession, the world’s steel production capacity has increased from 1.6 billion tons in 2008 to 2.4 billion tons in 2016. Three quarters of this increase has taken place in China. This had very little to do with global demand, which has been stagnating at around 1.4 billion tonnes since 2011. It was entirely driven by the domestic fiscal stimulus programme that the government initiated in 2009.
When the stimulus programme ended in 2011, local demand collapsed once more. In desperation, Chinese producers began ramping up exports at throwaway prices till they reached 100 million tonnes in 2015. This brought steel prices down by 39% in the US in the second half of 2015, and forced US Steel to lay off a quarter of its entire work force. The crisis has spread to other steel producers, like Corus and Arcelor Mittal, all over the world. Today China has an estimated 200 million tonnes of surplus steel production capacity and has promised to retire 150 million tonnes of it in the coming few years.
It is the same in coal mining and thermal power generation. 300,000 MW of generating capacity has been added since 2013 – more than India’s entire power generation capacity – but the demand for power has barely increased to accommodate the new plants existing plants are working at just over 50% of their capacity. Cement, non-ferrous metals, plate glass, oil refineries, and even the garments industry are in a similar plight.
But the problems these industries face pale into insignificance before those faced by the heavy engineering and construction industries that build the mother plants and machines of industry. If steel, cement, and power plants are being moth-balled to eliminate excess capacity, new plants will not be started till this is completed. This means that while steel production may fall by 20% , the production of machine tools, cranes, forges and blast furnaces will fall to zero. What will the heavy engineering and construction industries do in the meantime? Where will the workers go? At a time when its Mandate from Heaven is wearing thin for other reasons, this is not a problem that the Chinese government can ignore.
In actual fact, even closing down surplus steel and cement plants, power stations and coal mines is not proving easy. In January 2016, after two years of bumbled efforts to soften the impact of the slowdown and turn it into yet another ‘soft landing’, the central government finally announced, via an article written by an “Authoritative Personage” and published in the Peoples’ Daily, that it intended to eliminate the huge excess capacity by going in for “supply side structural reform’, i.e closing down non-viable enterprises and paying off the redundant workers, backed by limited amounts of demand stimulation.
But this is not proving easy, because during four decades of hectic growth, local government investments have developed an interlocking web of interests that has given them considerable power to resist, and even challenge, the directives issued by technocrats in Beijing.
For instance, the demand for coal depends upon the demand for power, which depends very largely upon the demand for steel and cement, which depends upon the demand for real estate. But most of the deposits of coal are concentrated in the poorer regions of China, notably inner Mongolia where coal mining is not only the main source of employment in many counties, but also an important source of revenue for the township and county administrations for meeting their administrative and developmental responsibilities. Eliminating surplus capacity in steel and power generation will therefore immediately create social unrest in the coal-rich provinces.
The see-saw struggle over reforms that is now developing between the centre and the provinces became apparent when, only four months after its announcement of supply side structural reforms in January, Beijing issued an explicit directive in April 2016, that it would permit plants and mines to be closed down only after alternate employment for the workers had been found. Clearly, local governments had had their way.
This is only the latest round in a the three decades-old struggle for control over developmental policies that was triggered by the winding up of centralised planning in the early 1980s and leaving the decision-making space open for local governments to take over. Beginning with taxation reform in 1994, every major directive for reform issued by the central government has met with the same mixed response. For Beijing therefore, guiding China’s development has been like riding a team of circus horses that have developed wills of their own.
China’s leaders have yet to come out with a comprehensive plan for economic recovery. But they know that all of their problems will become easier to resolve if the order books of these industries can be kept at least partly filled. Launch yet another fiscal stimulus programme to fill their order books, or invest in infrastructure and industry in other countries. The first will compound the folly of the last stimulus programme, so the second is the only way to go. That is the reason for the increasing importance China is attaching to its One Belt One Road initiative.
However OBOR will significantly mitigate China’s excess capacity only if India takes wholehearted advantage of what China has to offer. This is because India is the only country left in the world that is large enough to absorb , and therefore gainfully employ, China’s immense excess capacity in its steel, cement, plastics and heavy engineering industries, and thus enable it to ease its crisis of overcapacity.
Ever since China launched OBOR, most Indian analysts have regarded it more as a threat than an opportunity. Only a minority, consisting almost entirely of economists, have seen it as an opportunity to modernise India’s stone age infrastructure and pave the way for rapid industrialisation and employment growth. What it turns out to be will depend entirely upon what India wants it to be.
The incontrovertible fact today is that China has the finance capital, the technology and above all the overwhelming need , in its own national interest, to accelerate the development of these countries to an extent that could not have been imagined even half a decade ago. It is also an incontrovertible fact that the tunnel, road and rail links that it intends to build will pierce the natural ramparts of South Asia, the Himalayas, and end India’s geographical hegemony over the rest of south Asia.
If India chooses to stay out of OBOR it will only increase its isolation within South Asia, and hasten the end of its regional hegemony. But what will be even less excusable is that it will pass up a once-in-history opportunity to harness China’s economic muscle to India’s development. The way to avoid this is to join OBOR, invite Chinese investment in Indian infrastructure, and use the connectivity this creates to increase trade and investment with other south Asian countries and, of course, with China.
All this hangs in the balance upon the outcome of Wang Yi’s visit. If India sticks to its position that the resolution of the South China sea conflict must be rule based but also reiterates that the rules must be determined through negotiations between the littoral countries, and not through confrontation, and if it simultaneously indicates its readiness to join the OBOR initiative, China’s paranoia will abate on not one but two fronts. The road to further strategic cooperation between our two countries in BRICS and other fora will then remain wide open.