Forty years of domestic reform and opening up to international trade and investment have modernized the Chinese economy. Today it is a commonplace to describe China in terms of its market size: as a first mover in e-commerce, the world’s largest goods exporter, the largest car market, and the world’s leading consumer of energy and emitter of carbon. On 3 January 2019, China’s Chang’e IV spacecraft became the first to land on the dark side of the moon. By 2030 China’s middle class is projected to exceed a billion people, and its economy to be the world’s largest, overtaking that of the United States in nominal terms. Since Xi Jinping became leader of the Communist Party of China (CPC) in 2012, his policy focus has been a future-oriented long game to realize the dream of a transformed China: to become a technology leader and fully developed economy and global power by 2050.
Living with this transformed China will require an understanding of Chinese values and institutions and the leadership’s goals, both long and short term. Some of these are very different than those Canada espouses. Is there sufficient goodwill and mutual respect between the two countries to accommodate differences? For decades Western leaders, including Canada’s, accepted China’s planned economy as a phase in its development. They assumed that, with economic modernization, income growth, and integration into the world economy, China would become more like us, adopting Western liberal values and institutions and encouraging openness and democratization. Yet leadership changes and policy directions unveiled at the 19th National Congress of the CPC in November 2017 made it clear that China was on its own path, with its own development model of authoritarian state capitalism and managed markets, which continues to attract popular support among the Chinese people as long as it delivers economic growth.
Canada thus will have to learn to live with China on its own terms. Part of that learning, and a major theme of this book, is about President Xi Jinping’s emphasis on maintaining political stability by consolidating his power and inserting Party control more deeply into China’s economic life, even at the expense of other priorities of growth and employment, innovation, and modernizing the financial system. Part of that learning also involves Xi’s ambitious goals for China: to lead a new global order as it gains prominence in diplomacy, manufacturing, technology, and transcontinental connectivity in the Belt and Road Initiative.
As Xi proudly extols China’s development model and his global goals to domestic audiences, these projects and ambitions raise tensions with the West. In the United States, the Trump administration is an increasingly vocal critic of China’s push to dominate future technologies, and has complained of China’s failure to reciprocate its firms’ access to Western markets. Market distortions created by subsidies to targeted industries and state-owned enterprises (SOEs) are of specific concern, as are unfair business practices requiring foreign investors to form joint ventures, agree to forced technology transfers, and satisfy local-content requirements. According to estimates by the Organisation for Economic Co-operation and Development (OECD), China has the highest barriers to foreign direct investment (FDI) of any major economy. In early 2019, however, heeding the Trump administration’s sharp criticisms and fearing the risk of more punitive US tariffs and a costly and self-defeating trade war, China decided to liberalize its FDI policies, although the ambitious state role in advanced technologies remains.
China’s goals for its domestic economic strategy are evolving. The country’s economic reform was achieved largely by becoming the “workshop of the world,” based on investments in export-oriented goods production and taking advantage of foreigners’ interest in China’s plentiful low-cost labour. After four decades of “growth at any cost,” however, China’s growing middle class is now expressing increasing concerns about rising income and wealth inequality and the environmental costs of rapid growth. In 2007 former premier Wen Jiabao declared that the development model, so heavily reliant on exporting industrial production, had run its course and was “unsustainable, uncoordinated, unbalanced and unstable.” By the time Xi Jinping became leader, the Party had begun to respond to popular demands to realize more social and material gains. In 2017, at the 19th Party Congress, Xi announced a commitment to rebalancing domestic economic goals: “what we now face is the contradiction between unbalanced and inadequate development and the people’s ever-growing needs for a better life.” Resolving this contradiction involves downgrading official quantitative growth targets – even allowing slower growth. It implies replacing targets used for performance evaluations of officials at all levels with qualitative indicators. It also requires relying less on industrial growth and more on services-based, consumer-oriented growth, and less on simply adding more labour and capital, to increase output and more on innovation and technology. Official inspection tours in April 2019 emphasized anti-poverty programs and a new pro-business agenda.
This official shift of focus to an outward looking China with more centralized power has also attracted attention abroad and pushback at home. Xi’s strong state leadership emphasizes a reformed military and an attack on corruption, both seen as essential to consolidating the power to purify the Party of the dishonesty and cronyism that had become prevalent as the lines between Party and business blurred during the boom years of the 1990s.
But redrawing the line has sent mixed signals. Party cells became obligatory in the governance and strategies of both state-owned and private enterprises. Powerful interests were also affected, so the anti-corruption campaign helped to silence opponents, but with unintended outcomes. Many members of the legal community were alienated, and interest group leaders and officials were intimidated and increasingly reluctant to risk innovating or adopting new ideas. The Party now faces a profound political question: Can an unrepresentative, autocratic Party be sufficiently responsive to an increasingly demanding middle class?
Xi’s development model faces other challenges as well. Initiatives to promote “growth at any cost” relied on readily available state financing, which increased the indebtedness of businesses and local governments. Western analysts and foreign investors now voice serious concerns about the risks of widespread default and financial meltdown. They regard China’s economic growth, based on its unprecedented success in mobilizing capital and a vast supply of low-cost labour, as vulnerable to challenge by other fast-growing, low-income countries. China’s productivity growth and efficiency increases are a growing concern as Xi becomes increasingly statist, valuing political stability above all, willing to trade off efficiency to win the assent of powerful interest groups, and addressing concerns about labour layoffs by delaying the closure of aging, unproductive “zombie” factories. In short, the state as owner, producer, and regulator is ready and willing to delay economic reforms, however much they might be needed, if they pose a risk for political stability.
The Party faces a delicate balancing act between retaining its legitimacy and exercising its power to serve both the national interest and the interests of powerful groups and factions. At the end of Xi Jinping’s first term in 2018, the established two-term limit for the president was abolished, setting off an intense debate about the consequences. Widespread criticism depicted the rule change as personalized, self-serving, and a bid to monopolize power that rejected Deng Xiaoping’s collective leadership model of deal making and compromise. Even those who accepted it as necessary to consolidate leaders’ power in order to push ahead with key reforms considered it a bad decision. Since regional interests also play a key role in the balance of power, Xi’s regional experience might have been a contributing factor. Clues about his real intentions could be revealed in late 2019 at a scheduled meeting of the CPC Central Committee.
I return to these international and domestic dimensions of the long game in subsequent chapters. In Chapter 1, I focus on three challenges Xi and the Party face in “getting the economic house in order.” Addressing these challenges will require managing the tension between state intervention and market reform that figured so prominently in earlier Party deliberations. The first challenge is to maintain economic growth that is strong enough to avoid the political risks of a slowdown. Here, Xi’s clear preference for relying on the state as the engine of growth has starved the private sector of capital, forcing the authorities to impose lending quotas on state-owned banks. The second challenge is to modernize and open up China’s financial system. The status quo primarily serves the state, as in the days of the closed economy and central planning. A modernized system would feature the internationalization of China’s currency, the renminbi, allowing it to be widely used in global markets, with regulators and the central bank allowing market forces greater freedom. The third challenge is to address the low productivity of SOEs by reducing the politicization of economic decision making. Following implosions in equity and financial markets in 2015 and 2016, the slow pace of reform increased concerns about the Party’s declining commitment to market forces. Capital controls reduced outward investment, while deleveraging reduced private enterprises’ access to low-cost financing from shadow banks and gave SOEs, through their ready access to state financing, a new lease on life.
In Chapter 2 the focus shifts to innovation and productivity growth, which both Chinese and Americans agree are key to long-term sustainable growth. China has had some outstanding innovation successes in privately owned e-commerce enterprises. But it is the state that leads the ambitious “Made in China 2025” (MIC 2025) industrial strategy to push the country’s industry up global value chains in advanced manufacturing – and the state intends to do this with generous subsidies, top-down regulations, restricted entry of foreign producers, and unfair business practices. Exploring these strategies, I find evidence of the adaptation of existing technologies, rather than the creation of new ones. These adaptations respond to Chinese conditions of market size, speed of imitation, intense competition, and official support for innovation. There is also evidence of lesser-known, but significant and uniquely Chinese, changes in industrial processes in research and development (R&D) and innovation that effectively are accelerating economic change and increasing efficiency in a number of industries. The state’s willingness to protect innovators and producers from foreign competition by restricting entry is a contributing factor for the success of other enterprises. From China’s perspective, the dynamism of e-commerce and the successful adaptation of existing technologies suggest that these protectionist practices have served its short-term interests.
In Chapter 3, I examine China’s evolving financial system. The internationalization of the renminbi would be seen as emblematic of a great trading nation, but achieving this objective faces familiar tensions between state and market. Carefully sequenced market-based reforms will be required to create a financial system that is resilient in the face of market volatility while maintaining economic and political stability. To participate fully in the market-based global financial system, China will have to reduce restrictions on cross-border capital flows. The authorities will have to step back from overall control of the financial system, and concentrate instead on managing the risks to the currency of increased volatility due to greater exposure to external shocks to interest rates and economic demand.
The goal of internationalization adds urgency to the need to increase the transparency of China’s developing bond and equity markets, to introduce market-determined prices, and to reduce state ownership of banks. Indeed these priorities have superseded internationalization, as high levels of corporate and local government indebtedness have raised the possibility of default and a “hard landing.” Although recent reforms have rendered such an outcome less likely, state-owned commercial banks dominate the financial sector and are the main recourse for heavily indebted corporate borrowers, mainly SOEs, and local governments. In 2017 Xi warned that financial risk was a national security threat. Has he mobilized an adequate response? Are recent reforms – the restructuring of financial regulation, increased oversight by both the State Council and the central bank, and the creation of a high-level Financial Stability and Development Commission chaired by a vice premier – adequate to support China’s long game?
I turn to this long game in Chapters 4 and 5. Closely linked to China’s innovation and financial policies are its “going out” policies, which encourage both cooperation with and acquisition of foreign firms to acquire new assets and technologies. In Chapter 4 I examine China’s outward direct investment performance over the 2013–17 period as investments in North America and Europe surged before slowing markedly in 2017, when regulatory restrictions were tightened. A comparison of the top ten deals in 2016 and 2017 illustrates the tensions between market forces and state intervention in both sending and host countries. For example, although acquisitions of US firms dominated Chinese firms’ top ten deals in 2016, no US firms appeared on the 2017 list. A key driver of these foreign acquisitions was China’s slowing growth rate, which sent many investors abroad to seek higher-growth opportunities, while others sought to escape regulatory restrictions within China. The scale of these capital outflows and their negative effects on the exchange rate led to an official crackdown in 2017. Given the interventions by regulatory authorities and the central bank since then, what can one expect of China as a global investor in the years ahead? One clue was offered at the 2019 World Economic Forum in Davos, Switzerland, when the chair of Sinochem, one of China’s largest chemical groups, predicted that overseas investment by Chinese companies would slow at least until trade tensions eased with the United States.
The subject of Chapter 5 is the Belt and Road Initiative (BRI), a visionary but controversial infrastructure investment project intended to connect China, its Asian neighbours, and European and African economies. The BRI has been described variously as a twenty-first-century version of the fabled Silk Road and as China’s project of the century. These are early days, but already there is evidence that physical infrastructure and renminbi-based trading are helping to create new opportunities for the estimated seventy countries participating in the BRI, many on the periphery, that collectively account for 62 per cent of the world’s population and more than 30 per cent of global gross domestic product (GDP).
At the project level, however, the BRI has sent mixed signals in its initial five years. Many projects were structured to serve Chinese employment and business objectives, rather than assisting the development of local economies. Projects in a lengthening list of countries, including Pakistan and Sri Lanka, have drawn strong criticisms of China for practising “debt trap diplomacy,” whereby Chinese banks make loans that a country is unable to repay, forcing the debtor to use the assets from a project as repayment and effectively transferring local assets to Chinese owners. I review these and other lessons of the BRI’s first five years in Chapter 5, and note China’s new willingness to collaborate with multilateral partners such as the World Bank and the International Monetary Fund (IMF), which have long experience with funding large infrastructure projects. Of central importance are the design and preparation of investments to ensure they are “debt sustainable” – that debts incurred are of a size the borrower can repay without “debt distress” that requires debt reduction or restructuring.
Canada is the focus of Chapter 6. As a middle power accustomed to a unipolar world dominated by the United States, the implications for Canada of China’s international emergence are sobering. In particular, Canada will have to find its way in the increasingly complex relationship between China and the United States, its two largest trading partners.
China’s economic environment sends mixed signals about the relationship between the state and markets. Although Xi Jinping accords preference to relatively unproductive SOEs, other industries, such as e-commerce, make up a dynamic and highly competitive private sector that has to find ways to co-exist with SOEs, such as partnering with them and accepting Party cells to monitor social responsibility. The US critique of this increasing role of the state, of Chinese antipathy towards foreign entrants, and of their resort to unfair business practices are important sources of tensions in the US-China trade relationship.
As China becomes a global investor, it is increasing its leadership profile in international institutions. It is also pursuing cross-border initiatives, creating its own international development institutions, such as the Asian Infrastructure Investment Bank, and spearheading ambitious technological and international initiatives with MIC 2025 and the BRI. Can such initiatives sustain both competition and the cooperation necessary to maintain global peace and prosperity? The current US administration thinks the answer is “no,” for reasons relating to another theme in this book: Xi Jinping’s growing aspirations for China’s global influence and leadership in advanced technologies. Will China and the United States evolve towards geopolitical parity, or will China seek regional or global dominance? The United States’ definition of China as a strategic rival and revisionist power leaves little doubt about growing US mistrust, effectively abandoning a long-established policy of constructive engagement and deeper interdependence.
Canada’s interests unequivocally lie in peaceful partnerships and mutual accommodation. But the US extradition request for Huawei chief financial officer Meng Wanzhou and her subsequent arrest in Vancouver in December 2018 added a new dimension of complexity among the three governments, plunging the Canada-China relationship into a diplomatic deep freeze amid charges by Chinese officials that Canada was merely placating the United States. Canada will have to manage the relationship with China according to its own values and in pursuit of the the goal of reducing dependence on the US market. But Canada also must honour long-standing legal agreements with its US neighbour that make it difficult to bridge differences in Canadian and Chinese values and institutions and build mutual trust with China.
In Chapter 6, I propose elements of a China strategy that uses the relationship prior to the recent diplomatic deep freeze as the baseline. Canadians have been slow to learn about modern China and to accept that it is not, and will not be, “like us.” I argue that Canada’s strategic agenda should serve its long-term economic and security objectives. The agenda should recognize differences and seek to manage them, guided by leadership from the top. The narrative for deeper engagement should recognize not only Canada’s interest in diversifying its trade, but also China’s importance to Canada’s goal of a peaceful and cooperative world order.
In this broader context, I explore the possibilities for and ways to liberalize Canada’s trade and investment ties with China. I argue that the sine qua non is not necessarily a formal bilateral free trade agreement, which has been the subject of much political rhetoric and the focus of US criticism in the new US-Mexico-Canada Agreement (USMCA). Alternatives to free trade, such as sectoral initiatives and bilateral and multilateral economic partnership agreements, are widely used in Asia. Canada’s bilateral trade with China is largely complementary: Canada produces an abundance of natural resources, energy, and food, while China seeks security of supply. A new China strategy should also take into account Canada’s national security and defence priorities and its participation in East Asia’s regional security institutions. Beyond negotiations on traditional tariffs, quotas, and services, other trade-related issues should be addressed to bridge differences in institutions, laws, and standards, and policies developed towards cyber security, intellectual property (IP) protection, and privacy issues associated with digitalization and artificial intelligence.
Also part of this broader context are soft-power issues such as China’s treatment of its Uighur minority, the bad press generated by poorly planned BRI projects, actions against Canadians in China in retaliation for Meng’s arrest in Vancouver, and China’s rejection of Canada’s proposed gender, labour standards, and environmental issues on its progressive trade agenda. China’s use of the diaspora to influence policies and attitudes towards China has also contributed to a backlash in Canada. Rather than relying on bilateral modes of engagement, working with coalitions and allies might be a more effective approach for Canada.
The picture of Canada’s life with China is a dynamic and uncertain one. In the short term, decisions by Canadian courts will determine the prospects for continued engagement. Can the relationship be normalized if judicial proceedings in Canada reject the US extradition request for Meng even as other criminal charges play out in US courts? Will a ruling that permits Meng’s extradition continue the diplomatic deep freeze or worsen it? Whatever happens, Canada will need to continue to find a way to live with China by carrying through its commitment to promote trade, investment, security, and other common interests, seeking to engage Communist Party officials and civil society in the pursuit of global and long-term interests, while standing up for its values.