The Next Decade

by George Friedman

  Western China is a vast and quite empty near-desert surrounded by four non-Chinese buffer states: Tibet, Xinjiang, Inner Mongolia, and Manchuria. These anchor China at its geographical limits, with the Himalayas to the southwest, minimally passable but certainly not by armies and not by trade in any volume. Siberia lies to the north, a huge wasteland with no north-south transportation. Jungles and rugged hills lie to the south, stretching from Myanmar to the Pacific, isolating China from southeast Asia.

  Geographically, Japan is a much simpler place, consisting of four main islands and a series of much smaller islands to the north and south. It is being an archipelago that makes Japan by necessity a maritime nation, a fact compounded by an extraordinary geological reality: Japan is almost entirely devoid of the minerals needed by industry. Industrialization has always meant importing resources, including oil, which Japan gets primarily from the Persian Gulf. This means that Japan, by definition, has widespread global interests and vulnerabilities. Unlike China, which imports raw materials but has enough supplies of its own to survive if necessary, Japan would collapse in a matter of months if its imports were disrupted.

  Chinese Rainfall and Population Density

  China’s Terrain

  Partly because of its isolation and partly because it industrialized rapidly in the nineteenth century, Japan avoided the experience that China suffered at the hands of Europeans. The Europeans provided Japan with assistance in the form of industrial technology and military training. The British organized the Japanese navy, the Germans the army, and thus Japan evolved rapidly into a power that could challenge Europeans. Indeed, it defeated the Russians in 1905.

  The country most alarmed by Japan’s sudden emergence was the only other industrialized power in the Pacific: the United States. Prior to World War II, the Japanese imported raw materials mostly from southeast Asia and the East Indies. In order to secure access to these supplies, Japan needed a substantial military force, particularly a navy. The United States, which became a significant maritime power only at the end of the nineteenth century, saw Japan’s naval buildup as something that might one day drive the U.S. out of the Pacific. Simply by becoming an industrial and naval power, Japan appeared to threaten the security of the United States. By expanding its naval force to defend itself against Japan, the United States threatened the security of Japan.

  The result of this mutual intimidation was World War II in the Pacific. The United States defeated Japan not just because of the atom bomb and the success of its island-hopping strategy, but because its submarines cut off the supply of raw materials from the south and crippled Japan’s ability to wage war. Japan continued to resist, but once the U.S. submarine campaign placed a stranglehold on its supplies, its position was hopeless.

  Today Japan is just as dependent on maritime trade as it was in the 1930s and ’40s. It still must import all of its oil, and it must do so through waters controlled by the United States Navy. That means that Japan’s industrial position depends on the willingness of the United States to guarantee the sea-lanes. It also depends on the United States’ willingness not to take risks along Japan’s line of supply—particularly through the Strait of Hormuz.

  Thus Japan is trapped in a subordinate relationship with the United States. It cannot afford to alienate the United States without first building up a military force able to secure its own supply lines, but this is an undertaking far more ambitious and expensive than Japan wants to attempt during the next ten years. Nonetheless, its inherent insecurity because of import dependency, along with American unpredictability, will certainly drive Japan to become less dependent and exposed than it has been.

  Like Japan, the Chinese can ill afford to alienate the Americans. They depend on the United States less for the flow of raw materials (although Chinese ships also pass through waters controlled by the United States) than as a consumer of Chinese industrial products. China, like Japan before it, has become a huge exporter to the United States, so much so that the ability and willingness of the United States to buy is one of the foundations of the Chinese economy along with the European market. China must have access to both. Over the next ten years, China, like Japan, will be focused on preparing for what it sees as the worst-case scenario vis-à-vis its American trading partner, a political decision to limit Chinese access to the American market.

  To the extent that the regional balance will continue, it will do so not so much because of Japanese-Chinese relations but because of the relationship each Asian nation has with the United States. As China and Japan both become stronger, each will inevitably notice the other’s rise and become concerned.

  All other things being equal, Japan’s relationship with the United States will remain stable, but with China the story will be different. Exports stabilize China’s economy and society, but it is not enough to have buyers; it is also essential that the sale of exports build Chinese prosperity. If exporting to the United States no longer fits Chinese requirements, then Chinese interest in the relationship with the United States will shift and China will move away from dependency. Over the next decade, as China becomes more of an economic free agent, although not always a particularly prosperous one, Japan will have to have the United States guarantee its interests against China or shift its posture as well. Thus the balance that rests on the U.S.-Chinese relationship actually depends on how the Chinese economy functions over the next several years.

  CHINA AND JAPAN

  Part of the reason China was able to grow so dramatically in the 1980s is that Mao restrained growth just as dramatically up until that moment. When Mao died and was ultimately replaced by Deng Xiaoping, the mere shift of ideology freed China for an extraordinary growth spurt based on pent-up demand, combined with the native talents and capabilities of the Chinese people.

  Historically, China has cycled between opposites: either isolation combined with relative poverty or an openness to trade combined with social instability. From the 1840s, when Britain forced China to open its ports, to 1947 and the Communist takeover, China was open, prosperous in at least some regions, and violently fragmented. When Mao went on the Long March and raised a peasant army to expel the Westerners, he once again imposed relative isolation and reduced the standard of living for everyone, but he created a stability and unity that China had not experienced in almost a century.

  This oscillation between openness and instability and enclosure and unity is based in part on the nature of China’s primary economic asset, cheap labor. When outside powers are allowed to invest in China, they build the kinds of factories and businesses that take advantage of China’s abundant human capital. And yet the primary purpose of these factories is not to sell in China but to produce goods that can be sold in other countries. Accordingly, the primary focus of investment is near large ports and in areas with good transportation to these harbors. Because the population is concentrated in the coastal region, there is little reason to build infrastructure deeper within the country. Indeed, the vast majority of the factories are within a hundred miles of the coast. Even as China prospered and the factories became Chinese-owned, the pattern continued.

  According to the People’s Bank of China sixty million Chinese—a population equivalent to that of a large European country—live in middle-class households (those earning more than $20,000 a year). But with China’s population of 1.3 billion people, 60 million middle-class citizens represent less than 5 percent of the total population, and the overwhelming majority of those live in the coastal region or in Beijing.

  Six hundred million Chinese live in households earning less than $1,000 a year, or less than $3 a day for the family. Another 440 million Chinese live in households earning between $1,000 and $2,000 a year, or $3 to $6 a day. This means that 80 percent of China lives in conditions that compare with the poverty of sub-Saharan Africa. Even in the belt within one hundred miles of the coast, home to the 15 percent of Chinese who are the industrial workers, China is an extraordinarily poor country. Its narrow zo
ne of prosperity creates a chasm that is social as well as geographic. The region around the ports profits from trade, and the rest of China does not. The coastal region’s interests are in fact much more closely aligned with those of China’s foreign trading partners than with the interests of the rest of the country, or even with the interests of the central government.

  It is along these fault lines that China fragmented in the nineteenth century, and it is here that it may fragment in the future. Beijing balances between the impoverished majority and the prosperous minority. Supported by foreign interests, the well-off Chinese in the coastal areas will resist the central government. Attempts to transfer wealth either weakens the central government or forces it to become dictatorial. The Qing Dynasty weakened after the British incursion. Mao’s solution in the 1940s and ’50s was extensive repression, the expulsion of foreigners, and the expropriation and redistribution of wealth to the impoverished interior.

  During periods of relative prosperity and growth, the problem can be managed by the state. Even as inequality increases, the absolute standard of living for most Chinese rises, and that increase, however minimal, goes a long way toward keeping people passive. But what happens when the economy weakens and standards of living decline overall? For those in the middle class and above, this is inconvenient. For the more than one billion Chinese living in abject poverty, even a small contraction in living standards can be catastrophic. That is where China is heading in the very near future—toward a relatively small decline of growth, but one that will pyramid economically and socially, generating resistance to the central government.

  Given that China has a producer economy completely out of proportion to its consumer economy, the problem is inevitable. The iPods and clothing that China manufactures are not sold to its own impoverished masses. And yet China no longer has a wage advantage over countries like Pakistan and the Philippines. Given a limited pool of semiskilled labor (as opposed to its limitless supply of untrained peasants), the price of labor has risen. Pressed by competition, China has reduced prices, which has decreased the profitability of exports. In the face of increasing competition and of sluggish growth among some of its customers, China’s ability to compete will decline, increasing the difficulty of repaying business loans and thus increasing pressure on the entire financial system.

  The stark reality is that China simply can’t afford unemployment. Large numbers of peasants have moved to the cities to get jobs, and if they lose their jobs, they either stay in the cities and cause instability or return to their villages and increase the level of rural poverty. China can keep its people employed by encouraging banks to lend to enterprises that should be out of business, by subsidizing exports, or by building state-owned enterprises, but these efforts hollow out the economic core.

  Over the next decade, China will have no choice but to increase its internal security. The People’s Liberation Army is already huge. In the end, the PLA is what will hold the country together, but this assumes that this force, drawn heavily from the poorest segments of society, will itself hold together and remain loyal. To quell class resentments, China will have to tax the coastal region and the 60 million well-to-do Chinese, then transfer the money to the PLA and the peasants. Those being taxed will resist, and the revenues will be insufficient for those the government intends to benefit, but it should be enough to retain the compliance of the army.

  The long-term question, which will be answered in the decade to come, is whether the Chinese will attempt to solve their problem as Mao did—by closing off the country and destroying the coastal businessmen and expelling foreign interests—or by following the pattern of regionalism and instability of the late nineteenth and first half of the twentieth centuries. The only certainties are that the Chinese government will be absorbed with internal problems, working carefully to balance competing forces and increasingly paranoid about the intentions of the Japanese and the Americans.

  In 1990, Japan went through the kind of decline that the Chinese are beginning to experience now. Japan has a much stronger degree of informal social control than most outsiders can see, and at the same time the large corporate conglomerates, called keiretsu, retained a great deal of latitude. Having grown rapidly after World War II, the Japanese succumbed to a financial crisis made inevitable by their failure to develop a market system for capital. Their economy operated through informal cooperation among the keiretsu and the government. This cooperation was designed so that there would be no losers, and therein lay its fatal flaw.

  The capital problem was exacerbated by Japan’s not having a retirement plan worth mentioning, which meant that citizens were forced to save heavily, putting their money in government post office banks, which paid very low interest rates. The money was then loaned by the government to the large “city banks” linked to the keiretsu. This system gave Japan a huge advantage in the 1970s and 1980s, when U.S. interest rates were in the double digits and Japanese corporations could borrow at less than 5 percent. But the money was not being loaned to businesses that were inherently profitable. Most profit was derived from the added margin provided by cheap money. And the need for the Japanese to save a huge amount in order to retire meant that they were reluctant consumers. Thus the heart of the Japanese economy, like the Chinese economy today, was in exports, particularly to the United States.

  As competition from other Asian countries increased, the Japanese cut prices, which reduced profits. Lower profits meant that businesses had to borrow more money in order to grow, then found it increasingly difficult to pay back their loans. What followed was an economic crash that wasn’t noticed by the Western media until several years after it happened.

  Like the Chinese, the Japanese had to avoid unemployment, but for different reasons. In Japan, the reluctance to downsize was based on the social contract whereby a worker committed himself to one company for life and the company reciprocated. The Japanese honored the tradition by maintaining near full employment while allowing the growth rate to slip to almost nothing.

  Western economists dubbed the twenty years during which the Japanese economy stagnated the “lost decades,” but this is a misunderstanding of Japanese objectives, or rather the imposition of a Western point of view on Japanese values. Sacrificing growth in order to maintain full employment was for this highly cohesive society not to lose a decade but to retain a core interest.

  At the same time, Japan’s birthrate dropped well below the 2.1 children per woman needed to maintain its population. Now, with each generation smaller than the one before, the economy can no longer support retirees. In this way, debt and demography have created an enormous crisis for Japan.

  During the next ten years, the Japanese will no longer be able to maintain full employment by exorbitantly increasing their debt, both public and private. Like the Chinese, they will have to shift economic models. But the Japanese have one overwhelming advantage: they do not have a billion people living in poverty. Unlike the Chinese, they can absorb austerity, should it be required, without inviting instability.

  Japan’s fundamental weakness remains its lack of natural resources for industry, from oil to rubber to iron ore. To remain an industrial power, Japan has to buy and sell globally, and if it loses access to the sea-lanes, it loses everything. If trouble arises and it lacks the option of turning inward, Japan is far more likely to become assertive once again.

  THE SINO-JAPANESE BALANCE OF POWER

  For the past thirty years or so, relations between China and Japan have been secondary to each country’s relationship with the United States. The United States maintained the regional balance by maintaining mutually beneficial relations with each country, but those relations will shift in the decade ahead. First, China’s economic problems will alter its relationship to the world while transforming the country’s internal workings. Similarly, Japan’s internal problems and the solutions it chooses will transform the way it operates.

  Even when passive and dependent on other countr
ies to guarantee access to world markets, Japan always remains deeply embedded in the world. China is embedded as well, but not as irrevocably as Japan. The loss of imported raw materials does not represent an existential threat to China the way it does to Japan. Similarly, while China depends on exports, it could reconfigure itself if necessary, albeit painfully.

  China, then, has less of a temptation to become assertive; it also has less of an ability to do so. China’s main access to the world is by sea, but it does not have a substantial navy relative to geography and the United States. Building a naval power takes generations, not so much to develop the necessary technology as to pass along the accumulated experience that creates good admirals. It will be a long time before China can challenge either the United States or even Japan at sea. There has been a great deal of discussion of the development of China’s navy. Certainly, significant development is under way, but there is a huge gap between the present level of effort and what China has to do to challenge U.S. naval power even in the waters near China. The most significant developments are in land-based anti-ship missiles. But the Chinese have a very long way to go before naval vessels can hope to defeat an American fleet. And even the anti-ship missiles are highly vulnerable to U.S. air and missile strikes. China’s navy will not force the United States out of regional waters in the next decade.