The Economist The Pacific Age Under American leadership the Pacific has become the engine room of world trade. But the balance of power is shifting, writes Henry Tricks

The South China Sea is where that struggle is most visible. On modern maps the reefs and shoals between China, Vietnam, the Philippines, Taiwan and Malaysia are labelled “Dangerous Ground”—not because of their disputed ownership but because through history they have been a mariner’s nightmare.

According to Mr Hayton, the South China Sea itself plays an historic role in the crafting of the rules in contention. In 1603 the Dutch East India Company seized a Portuguese ship laden with raw silk and gold near the Strait of Malacca and hired a Dutch jurist, Hugo Grotius, to defend its action. He wrote a book in Latin called “Mare Liberum” (“The Free Sea”), arguing that the seas were international territory and should be open to all. Over the following centuries this was used by global powers as justification to sail merchant vessels where they liked, often with gunboats sailing alongside to enforce their authority.

Go by the book

Built loosely on “Mare Liberum”, UNCLOS established the EEZ concept which gave coastal nations exclusive rights over natural resources within a 200 nautical-mile limit but allowed for free navigation and overflights outside territorial waters extending to 12 nautical miles from the coast. Ironically, China has ratified UNCLOS whereas the American Senate has not—though in practice the American navy follows and attempts to enforce it.

But China’s interpretation (and that of a small group of large developing countries such as India and Brazil) differs from that of most states: it requires naval vessels to seek its permission before entering its EEZ. In 2013 a Chinese navy ship cut directly across the path of the United States Navy cruiser Cowpens, forcing it to change course abruptly to avoid a collision. Such incidents are red rags to the Americans. Their navy still regularly sends spy ships into China’s EEZ.

If China were to decide to enforce its version of the rules, the risks would be severe. In his book, “Fire on the Water: China, America and the Future of the Pacific”, Robert Haddick said it could mean the exclusion of foreign warships “from the Strait of Malacca all the way to Japan’s home islands”. Even if China were to keep the seas open to merchant shipping, the whole concept of maritime security would be jeopardised. America might be forced to retaliate.

That is an alarming scenario, though many security specialists say China does not seem to be spoiling for such a showdown with America, at least not yet. Optimists reckon that the Chinese navy, though growing fast, is ill-prepared for war with such a doughty opponent. Moreover, a defeat would be catastrophic for China. Security analysts say the Communist Party would lose its legitimacy and the trade-driven economy would collapse.

Pessimists argue that, even with good intentions on both sides, miscalculation or misunderstanding could still lead to conflagration. Chuck Hagel, America’s defence secretary, says America will oppose any effort to restrict overflight or freedom of navigation. It will “not look the other way”, he told his defence counterparts at the Shangri-La Dialogue in May.

In its island disputes, security analysts say China is picking fights with American allies that test the United States’ commitment to upholding the law by proxy, in steps small enough to make retaliation hard. But in the process it is gradually establishing “facts on the ground” in its own back pond. Euan Graham of the Singapore-based S. Rajaratnam School of International Studies says that eventually these could enable it to thicken its EEZ into a robust coastal buffer. He notes that Chinese history—such as Britain’s shameful Opium wars of the 1840s and 1850s—makes the country particularly sensitive to maritime threats.

That dashed line

All the disputed territories fall within what China calls its nine-dash line, which covers virtually all of the South China Sea and more than half of its neighbours’ own EEZs. Since it took over Mischief Reef in 1995, China has quarrelled with Vietnam over the Spratly Islands and installed some garrisons. It also occupied Scarborough Shoals after a stand-off with the Philippines in 2012. This year drilling by a big Chinese oil firm in waters 120 nautical miles (222km) from the Vietnamese coast sparked anti-Chinese riots in Vietnam. Tensions over the Senkaku/Diaoyu islands have been hurting relations with Japan since 2010.

Mr Haddick refers to China’s tactic of gradually enforcing these island claims as “salami-slicing”. It is “the slow accumulation of small changes, none of which in isolation amounts to a casus belli, but which can add up over time to a significant strategic change”. Ronald O’Rourke, a naval analyst for the United States Congressional Research Service, says Chinese officials have called it a “cabbage strategy”. The islands are wrapped, cabbage-like, in successive layers of protection formed by fishing boats, Chinese coast guard ships and finally naval vessels. China rarely deploys its armed forces in these creeping encroachments. Instead, says Ian Storey of the Institute of South-East Asian Studies, it uses maritime law-enforcement agencies. “Even the name implies China already feels it has jurisdiction.”

The tactic makes it harder for any claimant to launch a military response without appearing to raise the ante. “The Chinese are pursuing a pretty clever strategy and the rest of us haven’t figured out a good response,” says Admiral Dennis Blair, former head of America’s forces in the Pacific and now chairman of the Sasakawa Peace Foundation USA. He reckons that countries threatened by China’s “administrative aggression” should settle their territorial disputes with each other first and then present a united front to China. Mr Russel says “it is a good thing that China is not deploying the People’s Liberation Army’s navy.” But he points out that “whatever is driving the behaviour, the point is that it risks escalation and confrontation, so the exercise of restraint is necessary.”

In late September more than 18,000 American army, navy, air force and marine corps personnel took part in an unprecedented joint exercise off the Pacific island of Guam. Without explicitly saying so, it was aimed at testing responses to the sort of “sea-denial” strategy (missiles, submarines and cyber-attacks) that American military planners think China has developed to counter naval threats. According to Rear-Admiral Mark Montgomery, a Seventh Fleet commander, a Chinese auxiliary ship was spotted observing the exercises in America’s EEZ. That was the second time this year a Chinese vessel was seen snooping in American waters during war games. The Americans chose to treat it as a possible sign that China was exploring the benefits of their version of the UNCLOS rules.

Earlier this year naval chiefs from China, America and many other countries pulled off a surprise by signing the Code for Unplanned Encounters at Sea, which provides guidelines for naval ships or aircraft when they unexpectedly come close to each other. It offers a measure of potential damage control but it is not legally binding, nor does it apply in a country’s territorial waters, so it may be interpreted as subjectively as UNCLOS.

For China, the big question as it seeks to become a maritime power is how much it wants to project that status into the wider oceans beyond its neighbourhood. Singapore’s Mr Kausikan asks whether China will support a system that has benefited it or continue to be a “global free-rider”. That question is looming larger in the maritime sphere. As America becomes less reliant on Middle Eastern oil, thanks to its shale revolution, will China help to protect the sea lanes across the Indian and Pacific oceans for everyone’s benefit?

North American energy

Oil and water

North America’s energy revolution will have a ripple effect around the Pacific

Nov 15th 2014 | From the print edition

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TO FIND OUT how much energy security has mattered in the Pacific’s recent history, ask the Japanese. At the museum of the Yasukuni Shrine in Tokyo, which honours the country’s war dead (sometimes controversially), an exhibit suggests, with a jarring note of self-justification, that an American naval blockade against Japanese oil imports in 1941 triggered the Pacific war.

Seventy years later a tsunami that swooshed in from the Pacific and knocked out the Fukushima Daiichi nuclear power station led to the closure of Japan’s 54 nuclear reactors. Parts of the country, which is a greedy consumer of electricity, were left practically powerless. Huge tankers full of natural gas, heading for terminals dotted along Japan’s Pacific coastline, eventually got the country up and running again. In 2012 Japan consumed 37% of the world’s liquefied natural gas (LNG).

The past few years have seen some upheavals in the balance of energy security around the Pacific. America, which used to be the world’s largest net oil importer, ceded that spot to China in 2013 (see chart 4). Thanks to shale oil and gas, this year it is set to become the world’s biggest producer of oil and liquid natural gas. It is already the number one producer of dry natural gas.

That highlights the prospect of huge trans-Pacific complementarities. China is reducing the dominance of dirty coal in its energy mix, Japan and South Korea are denuclearising, and fast-developing countries like Indonesia are turning from LNG exporters to importers. Yet to date there is next to no trans-Pacific trade in oil, gas or coal in either direction; in 2011 the Singapore-based Pacific Economic Co-operation Council (PECC) said it added up to only 1.4% of global trade in those products.

According to statistics from BP, a global energy firm, North America gets most of its crude-oil imports from Canada or via its east coast from Latin America, the Middle East and west Africa. Asia receives the vast majority from the Middle East via the South China Sea. The Pacific is a big blank. But that may be about to change, with potentially big implications for the economic interdependence and geopolitics of the Pacific region.

Time to share the bonanza

The epicentre of the change is North America, whose huge gas discoveries are about to turn it into a global LNG power. In Canada Asian-owned companies plan to build the first export terminals on the coast of British Columbia in the next few years to ship LNG across the Pacific. In the United States the government has recently approved the construction of four terminals to liquefy gas and ship it west via the Panama Canal.

One of those, Dominion Energy’s Cove Point, near Washington, DC, built as an LNG import terminal in the 1970s, had been mothballed for much of the following three decades. Not long after it resumed receiving LNG imports in 2003, American natural-gas prices plummeted in response to the shale revolution, putting the terminal out of business again. So in 2011 Dominion switched to marketing Cove Point to foreign LNG customers as a potential export facility. On September 29th this year the Federal Regulatory Energy Commission finally approved construction of an export terminal. Those LNG exports will benefit from a $5.3 billion expansion of the Panama Canal. Due to be completed (after several delays) in 2016, this will make the canal big enough to accommodate nine-tenths of the world’s LNG fleet, potentially cutting at least 11 days off shipping times between the Gulf of Mexico and East Asia.

The implications of this new trade on both sides of the Pacific could be substantial. According to Jane Nakano, of the Centre for Strategic and International Studies (CSIS) in Washington, as of last year Japan had contracted to buy about a fifth of its LNG imports from America once it gets the necessary permissions.

Currently dry gas in America costs $4-5 per million British thermal units (MBTUs). Even allowing for another $6 or so to liquefy the gas and transport it to Asia (and far less from Canada’s west coast), the price would still be a lot lower than the $15-18 per MBTU that LNG currently fetches in Japan. Cheaper energy would make Japan’s economy more competitive, and America would see a much-needed improvement in its trade balance.

For American exporters, that scenario involves risks. Australia, one of the world’s two biggest LNG exporters, is ramping up its output over the next five years, much of it destined for Asia. China, another big potential buyer, appears to be avoiding American LNG. This year it signed a $400 billion deal with Russia to import natural gas from there for the next three decades.

But the energy markets of China and North America are warily intertwining in other ways, mainly through Chinese investment in oil. North America has received a flood of investment from Chinese oil companies since the global financial crisis. In 2012 CNOOC, one of China’s state-owned energy behemoths, bought Canada’s Nexen for $15 billion, seven years after its bid for America’s Unocal was scuppered by opposition in Washington. The welcome is not always open-armed. After the Canadian deal the prime minister, Stephen Harper, put a financial limit on further acquisitions: “Canadians have not spent years reducing the ownership of sectors of the economy by our own governments only to see them bought and controlled by foreign governments instead,” he said.

But Mexico, which in 2013 changed its constitution to allow foreign investment in its oil industry for the first time in 75 years, would welcome China with open arms if it wanted to invest in its energy sector, according to Ildefonso Guajardo, its economy minister. Tellingly, in the past two years Mexico’s president, Enrique Peña Nieto, has had four meetings with his Chinese counterpart, Xi Jinping—the same number as with President Obama.

The benefits of this new North American energy glut go far beyond the oil industry. For a start, it is making North American manufacturing more competitive. The combination of cheaper energy and rising Chinese wages could make Mexico a more attractive factory floor. But it is also sending two powerful geopolitical signals: one to America’s close allies, such as Japan and South Korea, that the friendship can now also help underpin their energy security; the other, to the wider Asian region, that North America has bounced back from the global financial crisis. In time, such symbols of economic revival could resonate strongly on the other side of the Pacific. Eduardo Pedrosa, the Singapore-based secretary-general of PECC, calls it a tectonic shift in American competitiveness. “I don’t think anyone over here realises how massive this shale revolution is for the US economy.”

Latin America

Pacific pumas

In America’s backyard, the Pacific economies are learning from East Asia

Nov 15th 2014 | From the print edition

Waiting for the new Panama Canal

ABOUT FOUR CENTURIES ago Latin America became central to the trans-Pacific economy, according to “Pacific Worlds”, a book by Matt Matsuda, an historian. Silver from Bolivia travelled by galleon from Acapulco to Manila, where it was trans-shipped to China and became a vital substitute for its debased currency. Back came silks, porcelain and slaves. One, an Indian noblewoman sent by slavers to New Spain, became famous for her long dark braids and colourful clothes. She was known as La China Poblana. Her dress sense, influenced by her Asian heritage, is now considered the epitome of traditional Mexican style.

After a long interlude, once again a roaring trade has developed between Asia and Latin America. It has quadrupled since 2004. Asia has overtaken the European Union as Latin America’s second-biggest trading partner after the United States. Latin America’s share of Asian trade is less impressive but has still doubled (see chart 5). China has the biggest share, swamping the region with its own products and gobbling up Latin America’s natural resources (see article). Two-way trade grew more than 20-fold in the ten years to 2013, and China has overtaken the United States as the biggest trade partner of Brazil, Chile and Peru.

Chinese investment in Latin America has increased, too, though the figures are murky because China parks much of its capital in tax havens in the British Virgin Islands and Cayman Islands before investing it. According to the UN’s Economic Commission for Latin America and the Caribbean, since 2010 China has been investing about $10 billion a year in the region. Thomson-Reuters, a data firm, says that since 2000 Chinese firms have announced more acquisitions in Latin America than in Africa or South-East Asia. Much of the investment has been energy-related. In contrast, Japan, the biggest Asian investor in Latin America, puts most of its money into manufacturing facilities to make things such as cars.

In the past few years Latin American exports across the Pacific have slowed as China’s economy has become less dynamic and commodity prices have dropped. The growing trade gap has given rise to two worries: that the region is relying too heavily on basic exports again and succumbing to a “natural-resource curse”, as it has done before; and that it will take the wrong lesson from China and embrace state capitalism. Leftist governments on Latin America’s Atlantic coast, such as those in Brazil, Venezuela and Argentina, which privatised heavily in the 1990s, have since moved strategically and in some cases ideologically closer to China.

The question is why Latin America has failed to match the success of the East Asian model. Augusto de la Torre, the World Banks’s chief economist for Latin America, explains: “After the second world war the East Asian economies linked up to Japan, and in the process of getting connected they created the ‘Asian Factory’. It became a virtuous circle. The better they connected to the world, the better they connected to each other.” Latin America’s post-war experience has been the reverse: “We were connected to the most important growth centre, the United States. But instead of the ‘Latin American Factory’, we got dependency theory, structural adjustment and a lot of disappointment.”

The World Bank says that East Asia’s poorer countries, whose GDP per person in the 1960s was a third of Latin America’s, have almost caught up. Between the 1960s and the late 2000s their productivity growth averaged more than 2% a year, whereas in Latin America it was only just above zero. Mr de la Torre points to lack of investment as one of Latin America’s main problems. Average investment rates have been stuck around 20% of GDP for decades, whereas in East Asia in the 1990s they averaged over 35% of GDP, so electricity and transport networks there are now far denser. East Asia has also made huge strides in education, which has improved the quality of its workers.

Antoni Estevadeordal of the Inter-American Development Bank (IDB) says the poor infrastructure has impeded trade within Latin America as well as the creation of inter-regional supply chains. In a recent report the IDB heretically suggested Latin American policymakers should look to East Asia and emulate aspects of its industrial policy, considered unthinkable in the “Washington Consensus” 1990s.

So far there are few signs that big multinational investors in Latin America are rushing to take advantage of the Pacific promise

Not coincidentally, such lessons are being absorbed most quickly along Latin America’s Pacific coastline. Four relatively open economies, Chile, Colombia, Mexico and Peru, in February signed a landmark trade pact, the Pacific Alliance, to strengthen economic ties to Asia. Their combined population is 212m and they conduct half of Latin America’s trade. They are already the most Asia-oriented in the region. Since 2004 they have signed or started work on at least a dozen free-trade agreements with Asian countries, with Chile leading the way.

Once Colombia has ratified the Pacific Alliance, more than nine-tenths of tariffs will be abolished and common rules of origin will help encourage the development of regional supply chains, says Andrés Rebolledo, head of Chile’s international trade division. The first priority is regional integration: the countries hope to improve air and maritime connections and court foreign investment to improve infrastructure links. They have already united their stockmarkets.

A hard act to follow

But they will struggle to match Asia’s success. East Asia’s economic integration started organically, with copious investment from Japan, and free-trade agreements came only after the nuts and bolts of commerce had been established. So far there are few signs that big multinational investors are rushing to take advantage of the Pacific promise. Geography—a long, straggling South American coastline versus a circle of trade around the South China Sea—may also be putting the pact at a disadvantage.

But other bold steps may help. Mexico, for example, has noted the galling failure of NAFTA to create a manufacturing hub anything like as vibrant as East Asia’s. It is suffering from an onslaught of Chinese imports, including industrial components that go into its own exports, so the government of Enrique Peña Nieto has embarked on far-reaching reforms to modernise the economy. They include measures to bolster competition where monopolies and oligopolies have dominated until now, such as in energy, telecommunications and broadcasting. One of the aims is to bring down electricity costs, improving Mexico’s cost advantage over China in manufacturing.

Japan has seized on Mexico’s promise. Last year Nissan opened a new $2 billion factory in Aguascalientes, its second in the state. New cars whirr off the production lines at the rate of almost two every minute. Mexico has overtaken Brazil to become the world’s seventh-largest carmaker and now exports not just to the United States but to South America too.

But Enrique Dussel Peters, a China expert at Mexico’s National Autonomous University, says the main lesson from Asia is that Latin American governments are not ambitious enough. He notes that only a decade ago China was making the same number of cars as Mexico is producing today, but now it churns out almost six times as many.

Directory: tlairson -> china
china -> The Asia-Pacific Journal, Vol 11, Issue 21, No. 3, May 27, 2013. Much Ado over Small Islands: The Sino-Japanese Confrontation over Senkaku/Diaoyu
china -> The South China Sea Is the Future of Conflict
china -> Nyt amid Tension, China Blocks Crucial Exports to Japan By keith bradsher published: September 22, 2010
china -> China Alters Its Strategy in Diplomatic Crisis With Japan By jane perlez
tlairson -> Chapter 5 The Political Economy of Global Production and Exchange
tlairson -> Chapter IX power, Wealth and Interdependence in an Era of Advanced Globalization
tlairson -> Nyt india's Future Rests With the Markets By manu joseph published: March 27, 2013
tlairson -> Developmental State
china -> The Economist Singapore The Singapore exception To continue to flourish in its second half-century, South-East Asia’s miracle city-state will need to change its ways, argues Simon Long

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