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Capital in twenty-first century China

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East Asia Forum

China’s inequality story received only scant attention in Thomas Piketty’s monumental new book, Capital in the Twenty-First Century. Piketty drew data mostly from sources in France, Britain, the United States and, to a lesser extent, Germany, Canada, Japan, Italy and Australia. These are all countries that have large quantities of capital and long histories of capital accumulation.

But now, as China is poised to become the largest economy in the world and also one of the countries in which inequality is rising faster than anywhere else. China could to a large extent define the contours of global inequality in the twenty-first century, just as Great Britain and the United States did in the nineteenth and the twentieth centuries respectively.

In the closing decades of the twentieth century, China had already begun to reshape the global landscape of inequality. On the one hand, economic growth of historical proportions lifted hundreds of millions of people out of poverty and raised the standard of living for one-fifth of humanity. A direct effect of China’s economic boom on global inequality was to reduce it, simply by closing the income gap between China and the richer parts of the world.

On the other hand, however, China has seen an extremely rapid pace of wealth accumulation, helping it to become one of the most unequal countries in the world, with a rate of increase in the last three decades that is virtually unparalleled elsewhere globally.

If one subscribes to Piketty’s core thesis — namely, that the key driver of increasing inequality is the rate of return on capital being higher than that of economic growth — then the future of inequality in China does not seem promising at all. Two megatrends, both inevitable, may drive up inequality in China: slowing economic growth and a rapidly ageing population.

As China’s average income level further approaches that of the developed world, rising inequality in China will also have an increasing global impact. Chinese wealth in recent years has already begun to show its power globally and at an accelerating pace.

Yet in a short three decades, the country has seen a rise first in income inequality, followed shortly thereafter by increased wealth inequality.

By the late 2000s, China’s Gini coefficient, a common measure of inequality, exceeded 0.5 — a sign of severe inequality. Wealth data in China is still hard to come by. From reports of extremely wealthy Chinese business people and corrupt Chinese officials, it is nevertheless easy imagine a much more unequal distribution of wealth than of income.

China has been able to survive such a massive increase in inequality so far, largely thanks to its high growth rate (over 10 per cent a year on average for nearly three decades) and the waning years of its rapid population growth. Rapid population growth tends to help reduce inequality, since it dilutes inheritances, while fast economic growth means that previously accumulated wealth becomes less important.

But both of these equalising forces are waning in China. A slow growth regime, both demographic and economic, has arrived. China’s demographic inflection point was reached a couple of years ago, when its demographic dividend, a measure of the effect of population age structure on economic output, turned from positive to negative. China’s current fertility level is only at around 1.5 children per couple and has been well below the replacement level for over two decades, with no signs of a rebound even though the one-child policy is being phased out. In a decade or so, the Chinese population will begin to shrink.

Meanwhile, China’s economic growth rate, which has been running at between seven and eight per cent since 2012, is already more than 30 per cent below the average for the preceding decade, and it will more likely than not slow down further. As China enters into a comparatively low growth regime, inherited wealth will quickly assume a new prominence. With it will come a new phase of Chinese capitalism.

A uniquely interesting feature of the Chinese low growth regime will be how wealth and demographics interact. China’s recent wealth explosion has benefited its urban population disproportionately more than its rural population. Many urban Chinese saw their wealth grow from virtually nothing to very high amounts by either inheriting their free apartments from the socialist era or by entering the urban real estate market early.

Rural Chinese are largely excluded from this process. Almost all urban families are one-child families. Inherited wealth in China will not only be concentrated but it will also be concentrated among people with the smallest number of children. Piketty’s argument about the deleterious effects of slow population growth on inequality is thus even more relevant for China.

A slow growth regime does not necessarily spell doom. Its effect on economic sustainability, social vibrancy and political stability depends largely on what political choices China makes now and in the years to come. ‘The history of distribution of wealth has always been deeply political’, Piketty reminds us. A wide array of policy choices is still available to China — from capital and inheritance taxes to the creation of a social safety net and channels of social mobility.

It will be interesting to see whether China’s political elite has the will to prevent further wealth concentration in its own hands.

Wang Feng is Professor of Sociology at the University of California, Irvine, and at Fudan University in China, and a non-resident senior fellow at the Brookings Institution.

This article is part of an East Asia Forum miniseries examining inequality in Asia and its implications.

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As China is poised to become the largest economy in the world it's also one of the countries in which inequality is rising faster than anywhere else.

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China sends minister to Taiwan

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China's most senior official ever to visit Taiwan has arrived on the island to discuss setting up liaison offices, sparking angry confrontations between pro-independence protesters and riot police.

The four-day visit by Zhang Zhijun, director of the Taiwan Affairs Office, comes as a further sign of warming ties between the former bitter rivals, despite vocal opposition from those opposed to forging closer ties with Beijing.

Zhang, who holds minister-level status, arrived at Taoyuan airport in the north of this island on Wednesday and was due to meet his Taiwanese counterpart Wang Yu-chi, chairman of Taiwan's Mainland Affairs Council, later in the day.

The two previously met in China's eastern city of Nanjing in February in the first government-to-government talks since Taiwan and the mainland split 65 years ago after a brutal civil war.

Wednesday's visit marks the most senior-level talks between the two sides to take place in Taiwan.

Ahead of the discussions, demonstrators tried to break through security barriers outside the hotel where Wang and Zhang were to meet and clashed with riot police.

Dozens of pro-independence and pro-unification activists also clashed in the airport.

Analysts say the meeting represents a further step towards normalising ties between Taiwan and the Chinese mainland. The two sides are still technically at war despite tensions easing markedly since 2008 when Ma Ying-jeou of the China-friendly Kuomintang came to power.

Moves by Ma's administration to further embrace China have also been hampered by massive student-led protests in Taipei earlier this year.

Despite improved relations, Beijing opposes the island participating in international organisations as a sovereign state and considers Taiwan to be a part of China awaiting reunification, by force if necessary.

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China appears to be warming towards Taiwan, sending its most senior official ever to visit the island to discuss setting up liaison offices.

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China state copper firm chief dies

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The head of a $US2.0 billion ($A2.16 billion) Chinese copper producer fell to his death from a building, the firm has announced, and a state-run newspaper said he committed suicide following corruption allegations.

The chairman of state-owned Tongling Nonferrous Metals Group, Wei Jianghong, died on Tuesday after falling off a building, the company said in a statement.

A string of officials have killed themselves in recent months, with speculation linking some to a crackdown on graft launched by President Xi Jinping after he took office last year.

State-run media said Wei jumped from a hotel owned by the company in Tongling, the city in the eastern province of Anhui where it has its headquarters.

The China Business News quoted a source as saying the incident might involve corruption since disciplinary authorities had initiated an investigation involving Tongling.

Tongling's profits have declined in recent years due to the sluggish world economy and slower domestic demand, reports said.

Its net profit for 2013 slumped 38 per cent year-on-year to 573 million yuan ($A99.54 million), according to an exchange filing.

Shares of Tongling, listed on the Shenzhen stock exchange, were down more than four per cent on Wednesday afternoon after the announcement, but its market capitalisation was still 12.7 billion yuan.

Tongling said authorities were investigating the incident and the board had appointed vice chairman Yang Jun as acting chairman. It added company operations were normal.

In April the deputy chief of the Chinese government agency that fields grievances from citizens, Xu Ye'an, killed himself in his Beijing office although the details surrounding his death remain unclear.

State media also reported that Li Wufeng, deputy director of China's government information department, "fell to death", also in April.

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The chairman of Chinese state-owned Tongling Nonferrous Metals Group has fallen to his death from a building, in the wake of corruption allegations.

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Iraq puts China's hard power failings on display

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Hollywood directors have unusually perceptive eyes for shifting geopolitical events. George Clooney produced and starred in a 2005 geopolitical thriller called Syriana, in which one of the main plot lines is the struggle between the US and China over oil interests in the Middle East.

The film featured Arabic-speaking Chinese oil executives who were willing to play ball with the local emirs, out-foxing their American competitors. The Hollywood fiction has since morphed into reality on the ground: Chinese state-owned oil giants are major players in Iraq now, often outbidding their Western rivals and importing 60 per cent of Iraq’s total oil production or 1.5 million barrels a day.

There is little doubt that China is the biggest beneficiary of the post-Saddam oil boom. Chinese oil companies are far more willing than their American counterparts to accept tight-fisted oil contracts from the Iraqi government and are more eager to take on risk and stay out of politics and religious strife in the country.

“We lost out,” said Michael Makovsky, a former Defence Department official in the Bush administration who worked on Iraq oil policy. “The Chinese had nothing to do with the war, but from an economic standpoint they are benefiting from it, and our Fifth Fleet and air forces are helping to assure their supply,” according to The New York Times. 

It is ironic that the expanding Chinese interest in Iraq is only made possible by the presence of American forces including the marines and Fifth Fleet, at the least until the withdrawal of the American military forces.

The rise of the Islamic State in Iraq and the Levant terrorist force is threatening the large and growing Chinese oil interest in Iraq and the Americans are no longer there and willing to ensure the security in the country and prop up the hopeless sectarian Shia government of Nouri al-Malik.

The Middle East is far less important to the US than before because of the shale oil revolution that came about as a result of the passing of the Energy Policy Act in 2005, which exempted hydraulic fracturing from the Safe Drinking Water Act.

America is now producing more oil than Iraq and Kuwait combined and is expected to surpass Saudi Arabia, the world’s largest producer, in the coming years. The chief executive of Exxon Mobil has predicted that the US will become energy self-sufficient within this decade.

The US’ reluctance to intervene in Iraq poses a stark dilemma for Beijing, which is heavily reliant on Middle Eastern oil to power its economy. Iraq is China’s fifth largest oil supplier behind Saudi Arabia, Angola, , and Russia. China has already overtaken the US to become the world’s largest importer of crude oil, according to the US Energy Information Administration.

Not only does China have oil interests in Iraq, estimated to be 31 per cent of oil reserves in the country, it also has scores of other investments from telecommunication networks to power-generators in the country. The non-oil major projects are worth about 16.8 billion yuan, or $3 billion.

The deteriorating security situation poses a stark dilemma for Beijing and there is little China can do to respond to the situation.

At the strategic level, there is a long-standing policy of not using military forces abroad and there is also the question about Beijing’s ability to project its military force at such a long distance away from China.

Beijing’s extreme caution is reflected in its on-ground security protection policy. Chinese security guards, many of whom are ex-Chinese Special Forces including senior non-commissioned officers from elite anti-terrorism squads, are not allowed to carry weapons.

Zhang Donghui, the deputy head of the Chinese Association of security Personnel told Global Times, a state-owned media publication, “In order to avoid unnecessary political troubles and respect the sentiment of the local Iraqi population. We are not allowed to be armed and can only use weapons such as batons for self-protection.”

The crisis in Iraq and earlier debacle in Libya shows that the emerging superpower is not yet ready to project its hard power abroad to protect its rapid growing economic interests. But there is growing chorus of people demanding Beijing adopt a more proactive policy to safe-guard its overseas interest. 

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China has been the biggest beneficiary of the post-Saddam oil boom in Iraq, but the US’ reluctance to intervene in the current crisis poses a stark dilemma for Beijing, and there is little it can can do in response.

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A freer Chinese currency proving popular

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China is making it easier to buy and sell its currency in order to expand trade and investment opportunities for the world's second largest national economy.

China has taken gradual steps to free up trade in the renminbi (RMB), also known as the yuan (CNY).

Before 2006, it was pegged at a fixed rate to the US dollar but it now trades directly with seven currencies, in a range of two per cent either side of the official rate set by the Chinese central bank.

The US dollar and the Japanese yen were the first and Australian dollar started direct trade early last year.

The latest addition to the renminbi club was the British pound last week, and the first in Western Europe.

Before that happened, someone with British pounds could not directly buy the Chinese currency, and instead had to buy a another currency like the US dollar to then buy renminbi.

HSBC head of RMB internationalisation Vina Cheung said direct trade lowers transaction costs and simplifies foreign exchange transactions.

"The direct trading between the pound and the CNY definitely has a very positive impact on RMB internationalisation," she said.

"RMB is gradually becoming a more market driven currency and expansion of the trading bands is in line with the strategic direction by the Chinese governments to be more market driven."

Ms Cheung said the Chinese government is also looking for more direct access with other currencies and said she is not surprised by the high level international demand for the renminbi.

In September last year, it joined ranks of world's most traded currencies, coming in at ninth compared to 17th in 2010, according to the Bank of International Settlements.

Trading between the renminbi and the Australian dollar has increased more than seven-fold in its first year of direct exchange.

Ms Cheung said many countries are now using the renminbi as a reserve currency - one that is held in significant quantities by governments and institutions as part of their foreign exchange reserves.

The Australian dollar currently buys 5.83 yuan - the primary unit of the renminbi, up from 5.6 yuan a year ago.

The US dollar is worth 6.23 yuan, up from 6.21 a year ago.

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There are now seven currencies that directly trade with China's renminbi, which simplifies foreign exchange transactions and reduces costs.

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Don't take China for granted: ambassador

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Chinese investor interest in Australia is growing but our ambassador to China is urging government and business not to take the relationship for granted.

Frances Adamson says Chinese investors are aware of opposition to foreign investment from some Australians but are increasingly interested in the great southern land.

Ms Adamson told a Sydney audience she thought the Australian public's attitude towards Chinese investment was beginning to change.

"What I hear increasingly ... is the supporters of Chinese investment ... more willing to put up their hand and say so," she said at an Asialink luncheon on Thursday.

She said Chinese trade had brought "real prosperity to Australian households" but the nation shouldn't become complacent.

"Australia must compete with other countries to attract Chinese investment," she said.

Prime Minister Tony Abbott led a party of federal ministers, state premiers and a 700-strong business delegation to China in April.

Ambassador Adamson called the trip a success and said the Abbott-Jinping (Xi Jinping, Chinese president) relationship had got off to a good start.

"It was clear the leaders were very much comfortable in each other's company," she said.

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Ambassador to China is urging government and business not to take the relationship for granted.

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Aust heads to world's biggest wargames

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For the first time, Australian warships will exercise alongside ships from the Chinese navy in the world's biggest maritime exercise off Hawaii.

This is Rimpac 14, the US-hosted biennial military manoeuvres in which 23 nations practise everything from disaster relief to advanced fighting on land, at sea and in the air.

China has sent a destroyer, a frigate, supply ship and hospital ship. Australia is sending submarine HMAS Sheean, supply ship HMAS Success plus aircraft and ground forces.

In all, 48 ships, six submarines, more than 200 aircraft and 25,000 personnel are taking part.

Australian Contingent Commander Rear Admiral Simon Cullen said Rimpac provided the Australian Defence Force with the chance to operate alongside regional neighbours.

"The exercise is a unique opportunity to build interoperability and cultivate ties with the armed forces of Pacific Rim countries. It reflects the closeness of our alliance with the United States and the strength of our military relationships with other regional defence partners," he said in a statement.

Rimpac 2014, the 24th since the exercise series started in 1971, runs from June 26 to August 1.

There's considerable interest in China's participation, at a time of growing tensions over territorial claims in the South China Sea.

Rimpac exercises involve live firing of guns, missiles and torpedoes, often using old US ships as targets.

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Australian warships will exercise alongside ships from the Chinese navy in the world's biggest maritime exercise off Hawaii.

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China to set yuan clearing bank in Sydney

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China will designate a clearing bank in Sydney for overseas trading of its yuan currency, a top Australian official said on Thursday as Beijing seeks to make the tightly-controlled unit more international.

The Australian financial capital would follow London and Frankfurt as a location for a Chinese bank to clear transactions in yuan, also known as the renminbi.

"I am confident that we will have, before the end of the year, a designated clearing bank for renminbi trading in Australia with the opportunity for an Australian bank to be a market maker," Australia's Treasurer Joe Hockey told the Australian Chamber of Commerce in Shanghai.

Beijing announced this month that the Bank of China would be the clearing bank for yuan dealings in Frankfurt while China Construction Bank won the bid for London.

Chinese authorities keep a tight grip on the value of the yuan and limit capital flows into and out of the country.

But China -- the world's second-largest economy -- is gradually moving to implement financial reforms by making its exchange rate more flexible and opening its capital account for investment and financial transactions.

The yuan remained the seventh most used currency for global payments in May, transaction services organisation SWIFT (Society for Worldwide Interbank Financial Telecommunication) said on Thursday although it accounted for only 1.47 percent of the total.

"China has come a very long way in relation to the renminbi," Hockey told journalists. "In many ways they've moved faster to deregulate their currency than many other countries and that hasn't been properly recognised by a lot of the critics.

"The best way to handle the Chinese in relation to the renminbi is to offer to be there to engage in facilitating more active trading, greater liquidity in various markets," he said.

Some major trading countries, notably the United States, have criticised China's pace of reform as too slow and called for Beijing to let its currency float more freely.

Chinese President Xi Jinping is due to visit Australia in November for a summit of the G20 group of nations, and Hockey said the two countries hope to reach a free trade agreement before the end of the year.

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China to designate a clearing bank in Sydney for overseas trading of the renminbi.

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Alibaba chooses NYSE for IPO

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Chinese internet giant Alibaba Group Holdings has said it will list its American depositary shares on the New York Stock Exchange under the symbol 'BABA'.

The company unveiled the move in another amended filing for its initial public offering.

The Wall Street Journal reported in March that the NYSE was the frontrunner to win the high-profile listing, which is expected to be the largest ever in the US by a Chinese company. The listing would mark a major prize for the iconic exchange and another setback for rival Nasdaq.

Alibaba said in March that it had decided to list its shares in the US rather than Hong Kong, ramping up the speculation about which of the two big American exchanges would secure the coveted assignment.

The two exchanges typically compete aggressively for marquee IPOs, offering discounts on certain fees, and promotional efforts to increase visibility of the listing. Representatives from NYSE and Nasdaq have been courting Alibaba CEO Jack Ma since the middle of last year, the Journal previously reported, citing people involved in the talks.

For the first time in at least 19 years, NYSE won more technology IPOs than Nasdaq last year, including the listing for Twitter.

Nasdaq has struggled to regain its position as the pre-eminent venue on which technology companies list their shares after it mishandled Facebook's IPO in 2012. The exchange also endured a high-profile stumble last year, when trading on Nasdaq-listed stocks was halted in August for three hours because of a software glitch.

Alibaba, meanwhile, is an online retailer that combines elements of American companies such as eBay, PayPal, and Amazon. For the past few years, Alibaba also has been increasing its presence in China's financial sector. The Alipay electronic payment system for e-commerce transactions has expanded into lending and financial products that allow Alipay users to invest in a money-market fund.

Alibaba amended its filing last week to include a host of details investors had complained were missing in its initial filing in May. Chief among them: a sales breakdown for the e-commerce company's two main shopping sites; names of the 27 people who control nominations for a majority of the board; details related to its Alipay online-payments affiliate; insight into the company's acquisition strategy; and more information on how the company is planning to handle shipping inside China.

Alibaba at that time also released new financial figures that showed the company's margins were under pressure -- falling to 45.3 per cent in the quarter ended in March from 51.3 per cent a year earlier -- due to rising spending to attract mobile users.

The broader disclosure in the first amended filing, which was released as part of a back-and-forth with US securities regulators prior to the IPO's approval, is aimed at making sure global investors are comfortable with Alibaba, which is a household name in China but relatively unknown in the West. That's particularly important because the offering could raise $US20 billion or more, making it one of the largest in history.

The listing is being planned for the first half of August, though the timing isn't set in stone. The company expects to shop the deal to investors globally, with large meetings in hubs possibly including Hong Kong, New York and London.

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Chinese internet giant to list on New York Stock Exchange in setback for tech-heavy Nasdaq.

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Abe's alarming assault on Japan's democracy

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Article 9 of the Japanese Constitution is one of the most unique in the world. It states that Japanese people “forever” relinquish war as a sovereign right and renounce the threat or use of force as a means of setting international disputes.

The current pacifist constitution was imposed on a defeated people by the American occupying forces after World War Two. Historians argue that article 9 is a direct translation from the English text. For a foreign imposed constitution cobbled together in the ruins of Japan, article 9 has been incredibly popular among the Japanese people.

For much of the post-war period, the Japanese Socialist Party, the main opposition party, regarded it as an article of faith. The party disintegrated after it abandoned this key electoral platform in the 1995 election.

The latest opinion poll in the liberal-left Asahi Shimbun newspaper found 63 per cent of people oppose the move to amend the pacifist constitution. The Norwegian Nobel Committee has also shortlisted “Japanese people who conserve Article 9” for its peace prize.

But the popular article has been under assault from the conservative Japanese government since the 1950s and current nationalist Prime Minister Shinzo Abe is making a renewed push to ‘reinterpret” it, making it easier for Japan to send forces abroad to fight alongside allies.  

For Abe, the push to reinterpret the constitutional restriction on its military force is really the second best choice. Ideally, he would like to amend the pacifist constitution and throw off the American yoke on his country. But it is not really feasible given the legal hurdles he needs to jump through: two-thirds approval in both houses of Diet -- the Japanese parliament -- and a referendum.  

Abe’s move carries significant risk and poses a threat not only to Japan’s democratic system of government, but also the country’s standing in the region and its security.

The Japanese people’s steadfast defence of the pacifist constitution is the best evidence of the country’s commitment to pacifism. And this is especially important at a time when the conservative government under Abe is trying to whitewash Japan’s shameful war crimes against its Asian neighbours during World War Two (The latent danger in Abe's amnesiaDecember 30, 2013).

Prime Minister Abe’s decision last year to visit the controversial Yasukuni Shrine, which honours convicted war criminals alongside millions of war dead, has sent the relationship between Japan and China into a deep freeze. Tokyo is also fighting a damaging publicity war with South Korea over the so-called "comfort women", who were sexual slaves during the colonial occupation.

If Japan attempts to re-interpret its pacifist constitution at the time when its relationship with its important neighbours is at their lowest ebb, it will only further inflame the situation in the region. It will only serve to strengthen Beijing’s claim that Tokyo is trying to revive militarism.

More important still, Abe’s push to reinterpret the constitution in the face of popular resistance and legal obstacles is undermining Japan’s constitutional democracy.

On this point, the Japanese government has a chequered history. The second paragraph of article 9 actually forbids the country from maintaining war materials to wage war, but it has been undermined consistently by the government and its American ally who wants Japan to shoulder a bigger security role. The fact is, Japan has one of the largest and most modern fighting forces in Asia despite its pacifist constitution.

Many Japanese constitutional scholars and lawyers argue that the very existence of the so-called self-defence force is unconstitutional. Legal challenges in the past had been thwarted by the conservative Supreme Court of Japan, which refused to hear cases relating to the legality of self-defence forces.

The Japanese government wants to change the letter and spirit of article 9 without going through the proper constitutional channels. As the New York Times eloquently put it, "[Abe] should know that the Constitution’s primary function is to check government power. It is not something that can be altered at the whim of the government. Otherwise, there is no reason to bother having a constitution at all."

Japan’s conservative government has been consistently and intentionally undermining the country’s cherished pacifist constitution for the past seven decades. Abe’s push is a threat to Japan’ democracy and regional stability and the country is not ready to abandon its most important symbol of pacifism when historical wrongs have not been settled.

It would be really ironic for Abe if the Japanese people were to be awarded the Nobel Peace Prize this year.  

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Shinzo Abe's attempt to re-interpret Japan's pacifist constitution is not only inflaming regional tensions, it's also undermining his country’s constitutional democracy.

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The flawed US indictment of Chinese hackers

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Graph for The flawed US indictment of Chinese hackers

East Asia Forum

On 19 May, the US charged five Chinese army officers with hacking into American companies in the first cyber-espionage case of its kind. In defending the administration’s actions, its lead spokesman, Assistant Attorney General John Carlin, adopted an indignant, highly moral tone, alleging that Unit 61398 ‘stole information particularly beneficial to Chinese companies and took communications that would provide competitors with key insight into the strategies and vulnerabilities of the victims…This is not conduct that responsible nations within the global community should tolerate’.

But in standing up to — and even taking action against — Beijing’s military and economic cyber sabotage, the US needs to present the world with a more precise and clearly delineated defence of why it undertook this action.

As Ariel Rabkin recently pointed out, part of the problem relates to the ‘dangerous’ precedent that the US is setting by holding that ‘uniformed military personnel can be indicted by foreign powers for activity conducted lawfully in their home country’. Given the sweeping activities of the NSA, ‘any hostile government, or impish prosecutor’ will be able to indict US security officials under this doctrine. Nor is there any ‘clear theory or doctrine of just how far national jurisdiction can be pushed’.

The 31-count indictment alleges that, among other offenses, members of Unit 61398 of the People’s Liberation Army conspired to commit computer fraud, accessed computers without authorisation, damaged computers through transmission of malware code and commands, committed economic espionage and stole trade secrets. The indictment identifies as victims five US-based companies — Westinghouse, Alcoa, Alleghany Technologies, US Steel, Solar World — and one labour union, the United Steel Workers.

What is striking about the indictment is that though conservative estimates of Chinese cybertheft of US intellectual property run to US$100 billion and beyond, the technologies named in the indictment, while not insignificant, are not at the cutting edge of US technology advantage. With respect to Westinghouse, the indictment cites theft of certain pipe designs and specs. Yet most of the stolen documents relate to negotiations for future business deals and Westinghouse’s future strategy for dealing with China’s State Nuclear Power Technology Corporation — certainly important documents, but largely unrelated to IP.

The same paucity of evidence of IP and technology theft characterises the indictments related to the other four companies. This has led Jeffrey Carr, a security analyst, to conclude: ‘The problem of IP theft by nation states is ongoing and relentless. If this is the best that the Department of Justice can do, things will get much, much worse for US companies’.

But the real gravamen of the administration’s case was the attempt to draw a clear line between two forms of economic espionage: stealing IP or trade/business secrets by government or even private hackers and passing that information on to individual domestic corporations, and stealing economic information for either non-economic reasons or to advance economic goals not specific to a particular corporation.

Much of the cyber theft detail set forth in the Pittsburgh indictment relates to trade disputes and cases that three of the companies (US Steel, Solar World, and Alleghany Technology) and the steelworkers union were involved with against Chinese companies. Though labelled ‘trade secrets’, the material basically related to strategies and pricing data to be used to further actions against Chinese companies.

The problem here is that such espionage activities are clearly within the orbit of actions taken (and vigorously defended) by the US government. The Snowden leaks provide an abundance of evidence in this area. For instance, in the US intelligence agencies’ ‘black budget’, there is a special section related to trade which states that the intelligence agencies will ‘directly support and strengthen’ trade enforcement actions and the goals of US trade negotiations. As to individual instances, the Europeans have been vexed at revelations that US officials exploited hacking in trade negotiations over the past decade — and gained access to European Commission information relating to antitrust actions against Apple, Motorola, Microsoft and Intel.

While there is no evidence that the US government gave information directly to individual corporations, the material gleaned from the spying operations certainly benefitted US businesses and workers. The larger point is, as New York Times reporter David Sanger has written: ‘The government does not deny that it routinely spies to advance American economic advantage, which is part of its broad definition of how it protects American national security’.

The sweeping, emphatic promise to go after all perpetrators of economic sabotage also presents future challenges. The problem, as former Defense Secretary (and former CIA Director) Robert Gates has pointed out, is that: ‘There are probably a dozen or 15 countries that steal our technology in this way. In terms of the most capable next to the Chinese are the French — and they’ve been doing it a long time’. Gates and others have pointed also to the Russians, several Eastern European countries, and the supremely competent Israelis. Does the administration really intend to follow through on Carlin’s sweeping commitment?

The point of this is not to call for a halt to US actions to counter Chinese (or other states’) economic sabotage. Rather it is to argue that the Obama administration needs to tighten and strengthen its case. For instance, among the voluminous and rich cyber files in NSA and CIA vaults, there must be striking examples of purloined technologies, the possession of which has allowed Chinese companies and sectors to leap to the forefront of world competition (the equivalent of China’s purported theft of the F-35 stealth fighter designs). Future indictments should target and widely publicise these technological thefts, in contrast to the trivial technologies that form the basis of the current indictments.

Second, it would be wise for the US to separate corporate secrets related to trade disputes and litigation from trade secrets related to future competitive strategies against Chinese (and other national) companies. The Wall Street Journal’s Holman Jenkins, Jr, lamented in regard to the current indictments that: ‘sadly the picture is mudded by Washington’s focus partly on data related to trade litigation and green subsidies, areas where an odour of cronyism wafts from our side, too.’ In the current indictments, there were strategic business strategies unrelated to trade litigation that were hacked from Westinghouse and Alcoa, but their significance got lost in the heavy emphasis on the trade disputes data.

Third, while it plays well politically and in the domestic media, the administration would be well advised to tone down its moral indignation against Chinese incursions. Though it may seem utopian at this point, at some time in the future America will have to reach an accommodation with China and other nations on the broad challenges of cybersecurity. Naming and shaming individual Chinese military units and individuals should be viewed as a necessary interim tactic, rather than a long-term solution.

This leads to a final point: Secretary Gates admitted that he does not know ‘where it goes from here.’ The administration is probably in the same position. Is the US willing to take more definitive action against Chinese companies — denying them access to US financial resources, or access to American markets, if they have been shown to benefit by IP theft (a hugely difficult case to prove, admittedly)? Is it willing to bear the brunt of retaliation from China against many of America’s world-leading high-tech companies, and to achieve credibility by taking action against other nations whose companies also benefit from economic spying?

None of the above is intended to place singular blame on the Obama administration: this is new territory and balancing economic and security national interests will be difficult and, potentially, treacherous. Getting the priorities and terms right in future Chinese indictments would be a good start toward a more carefully thought out set of policies.

Claude Barfield is a resident scholar at the American Enterprise Institute for Public Policy Research.

A version of this article was first published here in Tech Policy Daily and republished on the East Asia Forum. Republished with permission.

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The US needs to present the world with a more precise and clearly delineated defence of why it charged five Chinese army officers for hacking.

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Foreigners not pricing new buyers out of market: RBA

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Reserve Bank Assistant Governor Christopher Kent has poured cold water on suggestions that foreign investment in the local property market has priced out first homebuyers.

Mr Kent told the told the House of Representatives’ Economics Committee inquiry into foreign investment in residential real estate that the information available suggest "foreign residential purchases have probably not had a large direct effect on the price of housing that is typically purchased by first homebuyers".

Mr Kent added that while foreign buyers tend to concentrate on inner city apartments, first homebuyers generally purchase homes in the outer suburbs of the main cities.

His comments echo a report in the RBA's quarterly bulletin that said the degree of competition between local first homebuyers and foreign buyers is likely fairly small.

In an earlier submission, the Productivity Commission called for a holistic review of nation’s foreign investment rules saying Australia’s investment laws had made the country a "less attractive destination for foreign direct investment than would otherwise be the case."

Mr Kent also called for called for more timely and detailed data on the level of foreign investment from the Foreign Investment Review Board (FIRB).

"While incomplete, the FIRB data and the information received through our liaison with developers suggest that most foreign residential purchases are for new, higher-density, inner-city properties as well as properties close to universities," he said.

"Furthermore, the properties they purchase tend to be valued well above the average national sales price. In contrast, most purchases by first homebuyers have been for established homes that are priced well below the national average."

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RBA's Kent says foreign buyers focused on inner city dwellings, while first homebuyers eye outer suburbs.

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China a quick fix for Australia's infrastructure gap

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Australia can fast-track Chinese investment in much-needed infrastructure projects by lifting the threshold at which foreign investment comes under scrutiny, and even setting up a co-owned fund, say Corrs Chambers Westgarth lawyers.

China has been looking to invest its giant foreign exchange reserve of about $3.8 trillion.

“With its appetite for investment and deep experience in infrastructure, China can and should be an important investor in Australia's infrastructure,” said Corrs lawyers Andrew Lumsden and Lizzie Knight in a discussion paper. “The so-called ‘infrastructure deficit’ is real."

Australia needs an additional $770 billion, or about half of the country’s current GDP, to close the infrastructure investment gap over the next decade, according to Infrastructure Partnerships Australia estimates.

Australia is trying to seal a free trade deal with China by the end of this year, which will likely increase the foreign investment scrutiny threshold to $1.08bn from from $248 million for a private entity.

With investments from state-owned enterprises (SOEs) still a sticking point in the negotiations, Lumsden and Knight suggested a new “fast track” model for non-sensitive investment by Chinese SOEs below $750m based on behavioural undertakings.

Australia can also propose a fund co-owned by China Investment Corporation (CIC), China’s sovereign investment company, and the Future Fund, the lawyers said.

“Last year the Future Fund formed a $US300m co-investment company with the Boston-based Berkshire Property. … A similar model could be used for a CIC-Future Fund partnership,” they said, adding that the fund could process investment in infrastructure projects with no monetary threshold applicable.

Earlier this year, CIC’s chairman and chief executive Ding Xuedong said the sovereign investment company would be shifting its focus away from the energy sector towards infrastructure investment in both developed and developing markets.

"Australia is not alone in its need for infrastructure investment and needs to reinvent itself as being open to Chinese investment in spaces other than energy and resources," The paper said. "If we are to attract Chinese investment into local projects a key point of differentiation is a must -- skin in the game from the Australian government coupled with a fast track process may be that differentiator."

 (Reporting by maggie.lu@businessspectator.com.au)

(Editing by miranda.maxwell@businessspectator.com.au)

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Tweaked scrutiny thresholds and a tie-up with the Future Fund could solve a funding gap as China looks to invest its giant $3.8 trillion reserve.

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Chinese economy shows signs of life

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China's manufacturing sector showed signs of life in June, with two separate pieces of economic data showing activity rising in the month.

Official data showed activity in China's manufacturing sector expanded in June to its highest point so far in 2014.

The official purchasing managers index printed at 51 points in June, up from 50.8 points in May.

The data was in line with expectations after economists surveyed by Bloomberg forecast a read of 51 points this month.

Meanwhile, the HSBC China manufacturing purchasing managers' index (PMI) also showed manufacturing at a six-month high.

The HSBC China manufacturing PMI printed at 50.7 points in June, an improvement on the May read of 49.4 points, but slightly below the earlier flash reading of 50.8.

A reading above 50 shows the sector is expanding, while a print below 50 indicates contraction.

Chinese manufacturers signalled the first improvement in overall operating conditions for six months in June, while output rose for the first time since January.

Growth was supported by the strongest expansion of total new work since March 2013, while new export orders rose for the second month running.

HSBC chief economist China Hongbin Qu said the index confirmed the trend of stronger demand and faster destocking.

"The economy continues to show more signs of recovery, and this momentum will likely continue over the next few months, supported by stronger infrastructure investments," he said.

"However there are still downside risks from a slowdown in the property market, which will continue to put pressure on growth in the second half of the year.

"We expect both fiscal and monetary policy to remain accommodative until the recovery is sustained."

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Official data show strength in Chinese manufacturing in June, index at six-month high.

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Will China's anti-corruption campaign derail the economy?

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President Xi Jinping’s hardline anti-graft campaign has claimed the scalp of one of its highest ranking officials: General Xu Caihou, who held one of the most senior ranks in the military. He was also a member of the inner sanctum of political power -- the politburo. 

The arrest of General Xu, who has reportedly been under house arrest since March this year, signals the continuous escalation of Xi’s relentless drive to clean up the party’s endemic corruption. It was only a week ago that the party officially announced the investigation of Su Rong, who was a vice-chairman of China’s parliamentary advisory body and a former party-secretary of Jiangxi province.

The party has arrested 463 senior to mid-levels officials including dozens of ministers, generals and CEOs of state firms since December 2012, according to the website of the party’s anti-graft body. This does not include tens of thousands of more junior party cadres.

The arrests of General Xu and one of his protégées, Gu Junshan (a senior general in charge of the military’s logistics department) early this year highlights Xi’s determination to crack down on corruption in the most sensitive part of the party’s power structure, namely the armed forces. Mao Zedong, the founder of the party, famously said “political power grows out of the barrel of a gun”. Maintaining the support of military has always been central to keeping the party in power.

Though Xi’s anti-corruption campaign has been widely applauded in China, the voices of opposition are gaining momentum as well. Some are arguing that the hardline approach is damaging the credibility of the party as more and more explosive details of corruption and graft are exposed. Many are even using the economic argument that the anti-corruption campaign is dampening domestic demand at a time when the economy is under pressure.

It is quite telling that the retail price of Maotai, the favourite liquor of Chinese officials, has dipped below 1,000 yuan from 1,600 yuan a year ago. The wholesale price of expensive seafood like abalone, sea cucumber and farm-raised soft shell turtle have all declined considerably, according to AMP Capital.


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Patrick Ho, head of Asia Equities, told Australian investors: “One of the core problems post the three decades of growth in China comes from government corruption. The new leadership has shown ever-stronger effort to curb down the situation in China. The anti-corruption campaign has been more serious and has lasted longer than expected.”

“Many SOE executives and local government officials will be affected. This is positive for China in the long run, though may affect consumption and investment in the short run,” he said.

The impact on the high-end residential sector is also visible with many officials offloading their ill-gotten properties. Mao Daqing, the deputy chief executive of Vanke, the largest property developer in China, told a closed forum in Beijing last month that he had to receive at least 14 inspection groups from the prosecutor’s office and the central disciplinary commission of the Chinese Communist Party.

“For us developers, the impact of the anti-corruption campaign on the sales of high-end property is very serious. It does not only mean fewer corrupt officials are buying high-end apartments but also directly and indirectly related people and industries,” he said (What keeps China’s biggest property developer up at night, May 7).

Yes, anti-corruption is dampening the 'irrational exuberance' in some sectors, but it is addressing one of the most fundamental challenges for the Chinese economy. The logic is simple but worth repeating. Corruption and the associated problem of nepotism are not only undermining the political legitimacy of the party; they are also destroying business confidence.

Nobel laureates George Akerlof and Robert Shiller have shown in their ground-breaking book Animal Spirits how the last three great recessions (1990-91, 2001 and 2007) are connected with predatory and bad business behaviours. 

“These examples illustrate that the business cycle is connected to fluctuations in personal commitment to principles of good behaviour and to fluctuations in predatory activity, which in turn is related to changes in opportunities for such activity,” they wrote.

Widespread corruption is leading to shoddy construction standards. Many of China’s ultra-rich business people are snapping up foreign passports and relocating assets abroad as insurance policies and it’s needless to say inefficiencies are being bred throughout the system.

The anti-corruption campaign is not only the party’s last chance to stay in the power, it’s also vital for China’s economic reform. Fighting corruption is not only a political necessity but also an economic imperative.

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Xi Jinping's crusade against corruption may dampen domestic demand in the short-term but will ultimately serve the long-term interests of the economy and the Communist Party.

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China's yuan undervalued: Lew

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US Treasury Secretary Jacob Lew says China's yuan currency remains undervalued, a longstanding sore point that will be raised at next week's high-level bilateral negotiations in Beijing.

Lew said that the yuan, or renminbi, has appreciated 14 per cent since 2010, when China began taking small steps to allow its currency to trade more freely.

"It still needs to appreciate more. It's undervalued," said Lew, who will lead the US economic team at the US-China Strategic and Economic Dialogue (SED) in Beijing next Monday and Tuesday.

The value of the yuan is a highly sensitive political issue in relations between the world's two largest economies. The United States, while not branding China a currency manipulator, has long insisted the weak yuan gives China an unfair trade advantage.

Lew reiterated the US push for China to allow the yuan to trade at a market-determined foreign exchange rate.

"It's fundamentally not fair in terms of trading practices," Lew said at an event in Washington sponsored by the US-China Business Council.

Economic reforms set out in China's third plenum reflect US concerns "at a conceptual level" but have been slow to be implemented, he said.

Lew said he was "frustrated at the pace of change" and that if China dragged its heels in reforming for five or 10 years, it was "potentially disruptive" to the global economy.

The US needs confidence that the Chinese government is not intervening in the forex market to benefit trade. "Transparency will be a very important first step," he said.

Lew and US Secretary of State John Kerry will lead the US delegation to the sixth meeting of the SED.

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US Treasury Secretary says China's currency needs to 'appreciate more' ahead of Beijing talks.

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The truth about China's lies and statistics

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It is well known that China’s official growth statistics are highly unreliable. Premier Le Keqiang once told the American ambassador at the time that official statistics were ‘man made’ (read ‘made up’) and ‘therefore unreliable’, and that the only reliable indicators are electricity consumption, volume of rail cargo and loan disbursements.

If we follow this so-called ‘Keqiang Index’ (KI Index), then China’s GDP growth is under 6 per cent, rather than the official 7.4 per cent, which is unsurprisingly very close to the government’s official growth target of 7.5 per cent.

Readers might offer a disinterested sigh. After all, official growth in 2007 reached 12 per cent, while the KI Index said no more than 9.5 per cent. In 2012, the official number was around 7.5 per cent, even if the KI Index said just over 5 per cent. China is still the second largest economy in the world -- and growing damn fast, right? So who cares about a couple of percentage points here and there? Shouldn’t we leave that to the economic historians to iron out in a future time?

Well, when economies are growing rapidly and increasing their rate of growth, a few percentage points here and there are probably not that important. So whether it was 13.5 per cent or 12 per cent in 2010 doesn’t really matter.

But when the growth rates of an economy with a still very low per capita GDP (ranked around 90 in the world in between St Vincents and the Grenadines above it, and Namibia beneath it) is slowing or struggling as many (including this author) suspect, then such inaccuracies matter more for a number of reasons that I will shortly go into.

First, what does the KI index say?

It says that growth in the middle of 2011, 2012, 2013 and mid-2014 was about 12 per cent, 6 per cent, 6 per cent and 5 per cent, respectively. This compares to official growth rates in the same period of about 15 per cent, 7.5 per cent, 7.5 per cent and 7.4 per cent respectively. In other words, the KI Index indicates a clear slowing trend of less than 6 per cent.

In China’s case, whether it is growing at the government target of 7.5 per cent or closer to 5.5 per cent matters for the following reason. As all economists know, there are three things that can grow any economy: more capital, more labour, or using one or both more efficiently.

We all know that China has been throwing massive amounts of capital into its economy, especially since 2008, which technically increases GDP growth in the form of additional investment. But the economy generally gets plaudits for massive increases in labour productivity.

To wit, while labour productivity in developed economies such as Germany, France, the US and UK grew at only 0.4 per cent, 0.3 per cent, 0.9 per cent and 0.5 per cent respectively in 2013, emerging and developing economies enjoyed average labour productivity growth of 3.3 per cent in the same year. China was the star, boasting labour productivity growth of 7.1 per cent in 2013.

This is just as well since total factor productivity (TFP) growth in China, which measures the growth not resulting simply from additional capital or labour inputs (i.e. using capital and/or labour more efficiently) was non-existent. In other words, GDP growth was really just a function of increased fixed investment (which we know is not sustainable in China’s case) and gains in labour productivity since we know that labour inputs are not significantly increasing in the Chinese economy.

Let’s get back to GDP growth: If growth is actually 5.5 per cent rather than the official 7.5 per cent, a different economic story emerges out of China over the past few years.

According to official estimates, TFP added around 3.14 per cent of GDP growth in 2013, compared to 3.5 per cent by fixed investment, and 1.15 per cent by additional labour inputs. If growth was actually two percentage points lower at 5.5 per cent, and we were to make a proportionate reduction for the contribution to GDP growth by all three components, then TFP contributed about 2.3 per cent to GDP growth in 2013.

Given that almost all (if not all) of TFP gains in China in 2013 were from labour productivity rather than capital productivity (which may even be declining), then we can hypothesise that labour productivity in 2013 grew at just over 5 per cent rather than over 7 per cent.

But official statistics on capital inputs are likely to be underestimated if anything while labour inputs figure tend to be fairly close to the mark. This means that if growth was actually only 5.5 per cent in 2013 rather than the official 7.5 per cent, TFP needs to be trimmed more than the proportion-based approach above has done. If the 2-per-cent-lower GDP growth figure is largely accounted for by a reduction in TFP -- mainly a downgrading of labour productivity -- then Chinese labour productivity gains in 2013 are likely to be closer to labour productivity gains in countries such as Malaysia, Vietnam, the Philippines and even India.

The same analysis can be applied to the period 2012, as the discrepancy between the official numbers and the KI Index is similar. If so, this means that almost all of China’s superior economic growth is likely down to higher capital inputs alone. We all know the problems associated with that approach.

So think about what this means for China. It still has a very low GDP per capita and over one quarter of its people live on less than $US2 per day. Over 100 million are still below the poverty line figure of $US1.25 per day. Its debt-to-GDP ratio is over 200 per cent, and the fixed investment model is running out of steam. As its population ages, increases in labour productivity are the main hope for sustained growth. The trends may not be disastrous, but China is becoming a ‘normal’ economy with abnormally big problems. 

Dr John Lee is adjunct associate professor at the University of Sydney, non-resident senior scholar at the Hudson Institute in Washington DC, and a director of the Kokoda Foundation.  

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China's growth figures are notoriously unreliable and, as its economy slows, inaccuracies become even more important. All signs point to China becoming a normal economy... with abnormally large problems.

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Corruption is par for the course in China

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In a country with just 10 per cent of the world’s arable land and 6 per cent of its water resources, golf is often viewed quite dimly. Because of its voracious appetite for land and water, the sport’s critics have dubbed it 'green opium'. Yet despite an official ban on new golf courses a decade ago, it seems China's local governments can’t kick the habit.

Just last week, a Beijing Youth Daily investigation revealed that almost 3,300 acres of forest had been destroyed at Zilinshan National Forest Park in Guizhou, with the land to be converted into a 108-hole golf course and more than 30 villas. 

The developments are just one way cash-strapped local governments have exploited their roles as de facto land owners in order to raise revenue.

“Government officials in the provinces view golf as an attractive way to bring in a well-heeled clientele, to bring in tax revenue and most importantly to bring in money from land sales,” says Dan Washburn, author of The Forbidden Game: Golf and the Chinese Dream.

The moratorium on new golf course developments made by the central government in 2004 has all but been ignored. From 2005 to 2010, the number of Chinese courses tripled to more than 600.

“Rule number one is you don’t call what you’re building a golf course,” says Washburn. Instead, developers call the projects tourist resorts, health centres or sports training centres -- anything but a golf course.

Once they’re in place, the courses are taxed as an entertainment venue at a hefty 23.5 per cent rate, making it even more enticing for local governments. They do it because it’s in their best interests, says Washburn -- "whether it’s in the best interests of the people that they govern, that’s the other question".

In his revealing and fascinating book, Washburn looks at China’s recent development through the lens of a game that was denounced by Chairman Mao as a “sport for millionaires" when the Communists took control in 1949, and was completely banned until 1984.

"Golf is a topic that touches on a lot of issues at the heart of what China’s going through at this stage of its development," Washburn told China Spectator.

"It’s a barometer for economic growth but it’s also a symbol for the environmental issues the country faces, of the gap between rich and poor that is growing wider everyday. It allows you to talk about the kind of Wild West real estate development that’s happening, and then of course it's got its fair share of political corruption and intrigue.”

Once deemed a sport for older, wealthy white males, golf started to make its first inroads into Asia in Japan. But as the world’s third-largest golf market with over 2400 courses, the small island of Japan is well and truly tapped out.

While traditional golf markets have been flagging over the past decade, China has almost single-handedly been propping up the industry.

Ken Chu, CEO of Mission Hills golf courses in China, thinks the SARS virus deserves credit for the game’s increased popularity inChina. When the virus was spreading, more and more business deals were being done out in the open rather than in enclosed boardrooms.

But despite the size of China, the development of golf there is coming up against some insurmountable obstacles.

Chinese officials have called the nation’s water shortage a “grave situation” and have called for strict water controls. About two-thirds of Chinese cities are "water-needy" and 40 per cent of the country’s rivers are seriously polluted, according to China's vice minister of water resources, Hu Siyi.

Golf is still prohibitively expensive to play in China and as such is very much viewed as a rich man’s game. President Xi Jinping is rumoured to have enjoyed the game during his tenure as Governor of Fujian province but as his anti-corruption campaign steps up, no official wants to be seen playing the game. To do so would be political suicide.

The development of golf in China is likely to continue to be a barometer of change in the country. How the sport is dealt with will tell us a lot about the country’s priorities.
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Hillary Clinton's trade warning: Can China coerce Australia?

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Hillary Clinton believes Australia is too economically dependent on China, warning that dependence could 'undermine your freedom of movement and your sovereignty — economic and political'. Citing the example of European dependence on Russian gas, Clinton urges Australia to diversify its economic relationships. Is she right?

Economic dependence can be a problem in two ways. The first is 'sensitivity dependence', where one economy's health is tied to another's due to the depth of economic links between them. That is, 'China sneezes, Australia catches a cold'. A slowdown in China's economy causes a contraction in the construction and manufacturing industries, in turn reducing their imports of raw materials, depressing global prices and hurting our mining industry, especially higher-cost producers.

This is not a risk to be ignored, but even if Australia is sensitivity dependent on China, we're certainly not unique. Many countries — including the US — would suffer if China's economy fell off a cliff.

But Clinton is referring to 'vulnerability dependence'. This is a question of exit costs: how costly would it be for the two parties in an economic transaction to exit the relationship and find alternatives? The side that can do so cheaply has bargaining power, and in a political dispute could threaten the economic relationship as a way of achieving leverage. To use Clinton's Europe-Russia example, if it is easier and cheaper for Russia to find alternative customers for its gas than it is for Europe to find alternative suppliers, Russia has the upper hand.

How does this scenario play out for Australia and China?

It's true that over a third of Australia's exports go to China, but that statistic on its own tells us nothing about vulnerability. The important question is whether China could replace needed Australian imports at low cost. At present, this is a conversation about one commodity — iron ore — that overwhelmingly dominates Australian exports to China. According to the UN Comtrade database, iron ore comprised over 60% of Australia's merchandise exports to China in 2011, and China purchased almost 70% of all the iron ore Australia sold to the world.

But let's look this from China's perspective. Australian iron ore constituted almost 45% of China's iron ore imports in 2011. If we consider domestic iron ore consumption (ie. local supplies plus imports), Australia was responsible for roughly 20-25% of the total.

China is obviously a larger percentage of Australia's iron ore market than the reverse, but does this mean Beijing could stop buying Australian iron ore to punish Australia? This is not a crazy hypothetical. The Chinese steel industry attempted to boycott the iron ore spot market in 2009 to demonstrate its buying power during contentious negotiations over pricing with the 'Big-3' miners (BHP Billiton, Rio Tinto and Brazil's Vale). However, as Jeffrey Wilson details in his excellent book, Governing Global Production, the Chinese negotiating position was undermined when smaller steel manufacturers ignored the directive, choosing to take advantage of the much cheaper spot market prices. Individual profit motives thwarted larger strategic objectives, and China's steel industry was too fragile for the government to forcibly maintain a costly boycott.

Australian supplies are vast and cheap, and iron ore is a critical input into China's urbanisation and industrialisation, critical bases of the legitimacy of the Chinese Communist Party. It is not inconceivable that Beijing could decide to intervene in the iron ore market to place political pressure on Canberra — it would depend on how much China's leaders wanted to make a point. But doing so would come at a very high cost, one that Chinese firms might not be willing to pay for long.

This argument should not be mistaken for promoting overconfidence or arrogance in Australian foreign policy. China remains Australia's largest and most important trading partner, and managing the tensions between Australia's security alliance with the US and our economic interdependence with China is Canberra's greatest strategic challenge.

Nevertheless, Hillary Clinton's is wrong to imply that Australia's sovereignty is at risk. Evidence suggesting that our trading relationship with China renders us vulnerable to economic coercion is lacking. However, her suggestion that Australia should diversify its trade is still a good one, because it reduces the economy's sensitivity dependence on economic conditions in China.

Originally published by The Lowy Institute publication The Interpreter. Republished with permission.

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Why China-Australia FTA may still be some way off

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Last week treasurer Joe Hockey, and trade minister Andrew Robb were in China for the inaugural Australia-China Strategic Economic Dialogue. These talks are one part of the “Strategic Partnership” agreed to between the two countries in 2013.

Leading up to the event, media releases emphasised that the Economic Dialogue would be used to convey the message that Australia was “open for business” and in particular, to expedite the long-running negotiations for a free trade agreement (FTA). Initial reports after the talks saw the Australian side express optimism that a trade deal could be reached by the end of the year.

This is consistent with Tony Abbott’s pre-election pledge to strive to secure three FTAs (Japan, Korea and China) within his first 12 months as prime minister. Some have complained that Abbott’s self-imposed deadline needlessly weakens Australia’s bargaining position. After all, if a deal cannot be reached, it will embarrass Abbott more than his Chinese counterpart.

There is however, a much bigger threat to Australia’s negotiating position. That is the external environment in which a conclusion to FTA negotiations is being sought is less favourable to Australia than at almost any other time since discussions began more than eight years ago.

As I and others have written previously, for an FTA to be worthwhile from an Australian perspective, significant concessions by China are needed in the areas of agriculture and services. Given fears in China over food security and the plight of farmers who tend to be at the lower end of the income distribution, the implication is that Australia would need to come to the party with significant concessions of its own. However, Australia’s trade barriers are already low almost uniformly across the board.

The single most important factor providing some hope that China might be willing to make significant concessions was the scope for Australia to liberalise rules surrounding foreign investment. As it currently stands, nearly all Chinese investment proposals irrespective of value require Foreign Investment Review Board approval, in contrast to the A$1.08 billion threshold applying to investment from the US and New Zealand, and that will soon be extended to Korea and Japan.

For much of the past decade China has shown enthusiasm for investing in Australia, and in particular, in the natural resources sector. However, changes in the external environment are now eroding such enthusiasm.

One motivation underpinning Chinese investment has been a hedging strategy. As the prices of commodities such as iron ore and coal skyrocketed on world markets, while China may have suffered as a customer, by developing greenfield projects and/or taking equity stakes in existing miners, at least it could profit as a shareholder.

Australian and Chinese officials in discussion at the Great Hall of the People in Beijing, China.PARKER SONG/ POOL/AAP

However, output prices are no longer as high as they were, with the Reserve Bank of Australia’s Commodity Price Index down by more than 30% since 2011. Add in rising costs associated with project development and profit margins have been squeezed.

Chinese investment has also been motivated by a desire to achieve higher returns on its enormous stockpile of foreign exchange reserves than the traditional holdings of US Treasury bonds. While this was the expectation, the reality over time has proven quite different. Generally speaking, China’s experience of investing in Australia’s natural resources sector has not been a happy one. Numerous projects can be cited that have been funded in part or full by Chinese capital and that are now showing losses stretching into the billions.

There is also the possibility that Australian negotiators may have been able to hold up the prospect of eliminating tariffs on imports of Chinese cars, as had been done for Japan and Korea, and which currently stand at 5%. However, the demise of the domestic car manufacturing industry makes such an offer hollow. Irrespective of whatever trade deals are reached, the rationale for car tariffs has now disappeared.

It is perhaps not surprising then that according to data collated by Sydney University and KPMG, Chinese investment in Australia fell by 10% in 2013, in contrast to an overall global increase.

For its part, and perhaps responding to a wane in Chinese interest, the rhetoric of the Australian government has improved considerably. In 2012, responding to the possible non-commercial objectives of state-owned enterprises, Tony Abbott, then Leader of the Opposition, contended that “It would rarely be in Australia’s national interest to allow a foreign government or its agencies to control an Australian business”. In April this year however, he stated that he now understood that China’s state-owned enterprises these days are mostly highly commercial businesses, and just a few days ago, Joe Hockey stated that “We are open for business and that includes state-owned enterprises out of China”.

While this new tone will no doubt be welcomed by China, the above changes in the external environment mean that the bargaining chip of investment liberalisation is no longer as enticing as it once was. The conclusion is that while FTA negotiations may well be drawing to a close and an agreement of some sort soon signed, the prospect for a high quality Australia-China FTA remains as distant as ever.

The Conversation

James Laurenceson does not work for, consult to, own shares in or receive funding from any company or organisation that would benefit from this article, and has no relevant affiliations.

This article was originally published on The Conversation. Read the original article.

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The Australian government hopes to finalise the Free Trade Agreement with China by the end of the year but it could be some time yet.

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