Follow the money to Beijing

CHINA'S aggressive territorial claims in the East and South China Seas have often been in the news lately, usually portrayed as Beijing flexing its new-found political muscle.

But a different conclusion emerges from the economic perspective, unmasking China's recent aggressiveness as attempts by Beijing to address future weaknesses in the Chinese economy.

One of the main problems is China's reliance on fossil fuels and its high energy usage. China has now become the largest crude oil importing nation - over six million barrels per day and rising. Oil experts tip that China will have to import up to 10 million barrels a day in the next decade. At US$100 per barrel, this would be US$220 billion (S$279 billion) a year.

Feeding this hunger is the inability of domestic oil extraction to keep up with demand, as China's onshore fields are now mature, with heavy regulation preventing technological advances.

China needs to secure supplies and earn US dollars to pay for the oil. This is different from the United States, which has the privilege of being able to print as much US dollars as it needs to pay for imported oil.

Currently, China has no problem paying for oil imports. Its trade surplus - driven by manufacturing - was US$230 billion last year, although this may disappear if China has to import 10 million barrels of oil daily.

On top of that, the manufacturing future in China does not look too rosy. The rise in operating costs, advances in robotics and other factors have made assembly operations in China increasingly less attractive. Already, about 20 per cent of world manufacturing now takes place in China, which appears to be a peak.

China's overall foreign direct investment (FDI) - a long-term indicator of manufacturing activity and export performance - peaked in 2011. But for Chinese manufacturing FDI, the turning point may have been in 2006.

Manufacturing was 70 per cent of total FDI in 2006, versus about 38 per cent currently. In absolute numbers, manufacturing FDI is slightly lower now than in 2006. And it is a downward trend.

In five to 10 years, it is quite possible that China will be struggling with trade deficits. If it cannot pay for its imported oil, petrol will have to be rationed. Even if this does not cause unrest, the economy will get undone.

An oily situation

This is where the South China Sea comes in: Beijing believes that there are vast deposits of oil and gas in its seabed.

Official Chinese estimates are that there are 400 billion barrels of crude oil to be exploited, equivalent to about 50 per cent of the entire reserves of the Middle East. At current prices, this is worth about 19 times the size of ASEAN's economy.

The southern half of the South China Sea, fringed by the littoral states of ASEAN, is shallow, less than 100m deep, known as a continental shelf. During the last Ice Age, it was a vast tropical rain forest that connected Borneo to the Asian mainland. The area is thus a massive repository of accumulated fossilised flora and fauna - the ingredients of crude oil and natural gas.

Unlike the littoral ASEAN countries, China cannot afford to wait the five to 10 years to extract oil from the sea. Hence, there is a pressing need to make aggressive and outrageous claims in the South China Sea.

Some of the more outlandish ones include Malaysia's James Shoal, which is 80km off the coast of Sabah but 1,800km from the Chinese mainland, and Indonesia's Natuna Islands, from which Singapore gets its natural gas for power generation. Apparently, China does not claim the islands but the massive gas deposits.

China's behaviour may seem irrational but there is compelling realpolitik logic. Despite its outrageous claims, the world still appeases and continues to curry favour with the Chinese, giving them little reason for restraint. Indeed, the communists in Beijing are heeding comrade Lenin's famous dictum: "Probe with a bayonet: If you meet steel, stop. If you meet mush, then push."

Until the decisive flight of the US B-52s across its East China Sea air defence identification zone late last month, the Chinese have met largely mush. But appeasement is dangerous because it will eventually lead to a miscalculation, such as in Europe between 1936 and 1939. World War II started because of a miscalculation stemming from the appeasement of German leader Adolf Hitler. Economic struggles

The news and data flow from China is signalling that the country is having difficulties changing its economic model from an export-driven one to a consumption-led one.

China has said it needs 7.2 per cent economic growth to prevent urban unemployment from rising. This will be difficult to sustain going forward, for various reasons. Currently, the 7 per cent plus gross domestic product growth is being propped up by unsustainable stimulus in investments.

There is also a Catch-22 endemic corruption problem: China needs social and electoral reforms to fix corruption, but the vested interests of the corrupt are preventing the necessary reforms. No business can succeed if the management team is pilfering from its own shelves with impunity.

There is an assumption by many that China will eventually be the world's largest economy, surpassing the US, which is currently twice its size. But this may not come about if its GDP growth eventually slips to 6 per cent.

At 7 per cent, China's economy is currently increasing GDP by about US$580 billion per annum but at 6 per cent, that value would slip to about US$500 billion. Meanwhile, the US long-term GDP potential growth rate has re-accelerated to about 3 per cent because of the recent success with innovative domestic energy exploration, renewables and conservation. This translates to an expansion of US GDP by about US$500 billion per annum.

If China cannot, for whatever reason, get access to its imported oil, its economy will go into reverse. Indeed, a US naval blockade of China's oil imports in the event of a military confrontation - a possibility being discussed by some strategic thinkers - will be devastating to China's economy.

The realisation that China may fail to surpass the US in economic terms will impact geopolitics and how gingerly the world treats China in any display of steel.

Let's look at the worst-case scenario: Can the world survive without China's economy? China is a big economy but it is only 12 per cent of global GDP. If Google can prosper without China, so can the rest of the world.

Perhaps the more relevant questions are: Will the Chinese people want to live without the world economy as in the 1960s? Can the Communist Party survive without the world economy?

If Beijing does not succeed in its crude oil grab in the South China Sea, China will be akin to a paper tiger. ASEAN, on its part, must play its part by offering unified steel to ensure that the tiger remains a paper one.

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