Russia, China and the global financial crisis, published in French in l’essentiel des relations internationales, Janvier/février 2009.pp 42-46

    August 8,2008 is a date to be remembered as the day when the Beijing Games opened andRussiainvadedGeorgia. The opening ceremony’s grandeur spoke toChina’s millennial past, and its claim to status of the first rank in world affairs.Russia’s invasion of Georgian territory reminded the Europeans that their international institutions and complex dispute settlement procedures were frail guarantors of peace. Power politics , never absent, was more than ever prominent, marking the end of the dream of a world governed by international institutions and the rule of law.

So runs the argument of a world politics returning to its familiar pattern where what counts is the will to power, and the force of arms. A few days later, it was a rather different story. With inflation at 15% year-on-year, Russian markets were struck by capital flight as foreign investors withdrew billions of dollars from the economy, the fall in oil prices reduced state revenues, and the government had to pledge its considerable reserve funds to prop up equity markets and banks. The message about the facts of interdependence forRussia’s muscular leadership was simple: if you indulge in unpredictable actions which spook the global markets on which you depend, money can move.

Furthermore,Beijingrefused to sanction Russia’s action in Georgia. Here was another blow to the Kremlin’s dream of an alliance of major continental powers, embracingChina,India, perhaps evenGermanyandFrance, to contain theUnited States. Whatever the rights or wrongs ofRussia’s response to President Saakashvili’s provocations,China’s whole foreign policy is predicated on respect for the principle of non-intervention in the affairs of other states.

This is not to say thatRussia’s foreign policy excludes good relations withChina. Quite the contrary. Since the implosion of the Soviet Union, the withdrawal of Soviet troops from Indochina andAfghanistanbrought to an end the Chinese leadership’s nightmare of encirclement by an expansionistSoviet Union.Beijinghas jettisoned Mao’s claim to Siberia, cooperates withMoscowin  countering theUSpresence in Central Asia and the Caspian, and in October 2004 inBeijing, Presidents Putin and Hu Jintao settled the remaining disputes along their 7,000 kilometer frontier. The message was clear enough:China’s priorities are not so much territorial as development and insertion in global trade, symbolized by port construction and shipping activity along the eastern coast.

WhatRussia fears is China’s dynamism. This was evident at the conclusion of the October 2004Beijingsummit announcing the historic settlement over the Sino-Russian frontier. Putin told the journalists of his frank discussions with President Hu Jintao who was reported as pressingChina’s aspirations for  a continental energy system. “We have, he declared,  to be driven by our national interests.”  What Putin meant is that it is not inRussia’s interests to become over-dependent on a boomingChinamarket.

Underlying Russia’s fears of China is the growing strategic imbalance between the two. At the time of the Soviet Union’s disintegration, the Russian economy alone was equal in size toChina’s. By 2008,  China’s economy was over five times larger thanRussia’s, with a population expanding in the coming two decades from 1.3 billion at a minimum to a population of 1.6 billion or more. By contrast,Russia’s demography is declining from the present 146 million at the rate of 700,000 a year, and may reach 80 to 100 million by 2050. No wonder that there is widespread concern in Russian military circles thatChina’s future military capabilities, and that the Kremlin is cool about theChinaleadership’s aspirations for a pan-Asian energy strategy.

The fear is thatRussiawould become dependent on a vast China market, in short a vassal to the Chinese collective emperor. Paradoxically, the de-facto nationalization ofRussia’s natural resources, under the Putin administrations’ of 2000-2008,  has brought the prospect that much closer. The Russian energy nexus is the heart of the Russian state and economy. It accounts for two thirds or more of equity on the Russian stock market; oil and gas make up over 50% of total exports, provide 40% of central government revenues, provide nearly half of Russian output, and supplies upwards of 80% of Russian foreign exchange earnings. It is through promotion of the state corporations–Gasprom, Transneft and Rosneft—that the Kremlin seeks to control Siberia, exercise extensive influence over the ex-Soviet geographic space, and structureRussia’s export policy.

IfChinawere to import all the energy it needed from Russia, and Central Asia, rather than from the Mid-East and the Gulf,Chinawould lessen its potential vulnerability toUSnaval predominance  in the Indian Ocean, around theMalaccaStraitsand theSouth China Sea. ButRussia’s state would become dependent onChinafor its revenues.

The implications of this Russian fear for world politics is clear enough. First, the Kremlin has no intention of fostering such dependence. End 2004, the Kremlin announcedRussia’s intent to build a pipeline for oil, not toChina, but to Japan—a country with which it had not yet signed a peace treaty and with which it had many unsettled territorial disputes.Russia’s prime partner for energy is Germanyand the EU—altogether a less worrying client.  The EU takes 70% of the CIS fuel and mining exports, as againstChina’s 11%.Germanyis the Kremlin’s prime objective ally inEurope, to use a hackneyed Marxist phrase.

Second,Chinahas no option but to accentuate its future energy dependence on the Mid-East and the Gulf, and on the markets ofJapan, the US and the EU for its hard currency earnings. The paradox here is thatChina’s structural surplus with the result of the world leaves it vulnerable to protectionist backlashes, to currency instability, and with no-where else to invest in the current global financial maelstrom than in the industrial world.Chinalooks a predator, let lose since its entry to the WTO on the global trading system, but on closer examination its whole strategy for growth and development to escape the drama of theSoviet Union’s experience, makes it dependent on the industrialized world. These are some of the ambiguities and fears weakening the political underpinning for the global trading system.

Little doubt that Chinais viewed as a mercantilist power seeking all opportunities to run large trade surpluses and build foreign exchange reserves. In a poll conducted by the Financial Times between March 27th and April 8th, 2008 in five European countries (Italy, France, Germany, Spain and the UK), 35% of respondents  saw China as a bigger threat to global stability than any other state.[1]

In fact,China’s return to the global economy after centuries of absence has transformed the Chinese and the world economy.China’s exports have grown in volume by 30% a year since 2000, while their relative prices have fallen, displacing low skilled labour in southern Europe andMexico, and benefitting countries with an acquired advantage in skilled work, such asGermany. More intense competition fromChinahas kept prices down, and –until recently-helped western central bank’s anti-inflationary policies.

In particular,Chinahas acted as an engine on growth for its Asian, Latin American and African suppliers.China’s imports have been growing twice as fast as developing country imports for the last decade, and three times faster than industrial country imports. It has become a regional manufacturing base for the production of consumer goods, and a growing importer of intermediary goods as its trade barriers fall. As a result, greater specialisation has emerged among Asian countries, withChinabeing the central link between Asian trade partners and industrial countries markets.

The same ambiguities and fears underpinChina’s foreign exchange policy.Chinastands accused of managing an aggressive currency policy. At the peak of the Asia-Pacific financial crash, when Asian currencies depreciated by 20-80% in 1997-98, Beijing stabilise the currency at a dollar-RMB rate of 8.27, and clung to that rate until June 2005, when the top leadership decided to revalue the currency by 2.1% against the US dollar. The result was a surge inChina’s export-led growth rate from an 8% average from 1998-2001, to a 10% average from 2003-2005,  to over 11% average from 2006-2008.

Cumulative appreciation of the renminbi against the US dollar since the end of the dollar peg in June 2005 reached 15% in January 2008. Given labour productivity increases at 9.5% per annum driven by massive restructuring and marketisation, a step-by step approach to currency policy ensuresChinaa competitive exchange rate into the future. Labour productivity rising in excess of  the revaluation of the RMB to the dollar ensures continued improvements inChina’s export competitiveness in terms of unit labour costs. This is turn,China’s critics maintain, has stimulated the rush of global corporations to exploit the opportunities thatChinaoffers of cheap labour, subsidized energy and an undervalued currency. Over 60% ofChina’s exports come from subsidiaries of multinationals, asChinahas become a choice location in buyer driven commodity chains.

Another interpretation of China’s insertion into global business networks is more instructive than this tale of Chinaas indulging in beggar-thy-neighbour practices. Chinahas little incentive to become another Japanwhen circumstances over sixty years after the end of the world war are so different. Japan’s business system built up in the 1950s was closed and geared to “export out, protect in” has little to recommend it as a model for Chinain the 21st century.  China’s economy is incomparably more open and its business system in dynamic transformation as it seeks to adapt procedures and institutions required in a market economy. As Long Yongtu, China’s chief negotiator at WTO, stated, we joined the WTO “to push forward economic reform…so that China can participate fully in economic globalization”[2]

The reason for the huge surpluses accumulated since 2001 is not that foreign corporations have found the Chinese market impenetrable, but that Chinese household and corporate savings rates have aggregated year-on-year to 40-45% of national income.  As national income(NY) equals consumption(C) , plus saving (S), plus imports(M), high savings come at the expense of lower consumption and lower imports. In other words,Chinais producing more than it consumes. It is in structural surplus, until its savings rates change. This is the key toChina’s present lack of alternatives to that of helping to re-capitalize the western banking system.

With a small deficit recorded under services, and rising income from international business, China’s current account surplus mushroomed from 1.3% gdp in 2001 to 11.5% in 2007. There was not much net, recorded movement on capital account, given prevailing capital controls. But the controls did provide an additional incentive to foreign investors to get into the Chinamarket,[3] as evidenced in the financial account, where the largest item was inward direct investment, amounting to 3.3% gdp in 2001, and rising to 4.4% gdp by 2007.

The Central Bank actively absorbed this huge inflow of funds, partly by accumulating foreign exchange reserves, partly by re-investing abroad and partly by accepting an expansion in the domestic monetary base. Foreign exchange reserves stood at a colossal $ 1,8 trillion dollars by mid-2008, and rising at an accelerating rate of over $500 billion dollars a year. These assets give the Chinese state the means to re-capitalise their own banks, continue preferential lending to enterprises within the party-state family, buy US Treasury bonds, bribe dictators, bail out western banks and purchase equity in mineral operations around the world.

The counterpart to that is that global corporations in the Chinamarket seek a return on capital of 15% per annum, whereas the returns for Chinese paper invested, say, in the US Treasury bond market is 4%. As Charles Dumas of Lombard Research has demonstrated, Chinamakes 1-2% interest on its dollar reserves. It then loses regularly on the exchange rate as the dollar falls relative to the renmimbi, and suffers an inflation rate of 6% per annum, for a total return in local currency of about minus 15%. That is a loss, which Dumas calculates as amounting to about 7-8% gnp a year. [4]China is running hard to stand still.

It we accept, for the moment, the thrust of this argument, the conclusion for the foreign policy agenda of a President Obama, or a President McCain, is indeed that not so much that power politics is back in the global driving seat. What the incoming administration has to address is the underlying fears and ambitions that inform the policies of major states.RussiahasGermanyas its objective ally in Europe, thereby playing toFrance’s traditional policy, revived under President Sarkozy, of basing its European policy on prior alliance with theUnited States.

Chinais an indispensable partner for theUnited Statesin dealing with the current financial meltdown in the financial heartlands of the western world. Indeed,China’s massive current account surpluses have played a central role in the “global imbalances”, to which the Chinese leadership constantly refer. But revolving those imbalances as far asChinais concerned is not going to be furthered by western capitals pressingChinato open its markets. They are already very open.

The challenge goes much deeper. It is to get Chinese companies and households to reduce their very high savings rates. Chinese corporates are flush with cash, following the shakeouts of the last decade. Chinese families save as much as they do because they do not yet entirely believe that the 200 years of da luan—the bad times, which started around 1800 and began to come to an end in 1978—are fully behind them.

All the western powers can do is to contribute to promoting that confidence by creating as stable a context forChina’s future, inevitable political and economic development as possible. All that the Chinese leadership can do is to help bail out the western financial system. The reward will be to ensureChinaa seat at the rich world’s high table.Germanycan be relied on to protectRussia’s claim.


[1] Financial Times, Ben Hall and Geoff Dyer, China Seen as biggest threat to stability, April 15th, 2008

[2]Beijing Youth Daily, March 26, 2001

[3] See Eswar Prasad, Shang-Jin Wei, “The Chinese Approach to Capital Inflows: Patterns and Possible Explanations”, NBER Working Paper, No. 1136

[4] Charles Dumas,China andAmerica: A Time for Reckoning, Pbk,London, 2008.

About Jonathan Story, Professor Emeritus, INSEAD

Jonathan Story is Emeritus Professor of International Political Economy at INSEAD. Prior to joining INSEAD in 1974, he worked in Brussels and Washington, where he obtained his PhD from Johns Hopkins School of Advanced International Studies. He has held the Marusi Chair of Global Business at Rensselaer Polytechnic Institute, and is currently Distinguished Visiting Professor at the Graduate Schoold of Business, Fordham University, New York. He is preparing a monograph on China’s impact on the world political economy, and another on a proposal for a contextual approach to business studies. He has a chapter forthcoming on the Euro crisis. His latest book is China UnCovered: What you need to know to do business in China, (FT/ Pearson’s, 2010) ( His previous books include “China: The Race to Market” (FT/Pearsons, 2003), The Frontiers of Fortune, (Pitman’s, 1999); and The Political Economy of Financial Integration in Europe : The Battle of the Systems,(MIT Press, 1998) on monetary union and financial markets in the EU, and co-authored with Ingo Walter of NYU. His books have been translated into French, Italian, German, Spanish, Chinese, Korean and Arabic. He is also a co-author in the Oxford Handbook on Business and Government(2010), and has contributed numerous chapters in books and articles in professional journals. He is a regular contributor to newspapers, and has been four times winner of the European Case Clearing House “Best Case of the Year” award. His latest cases detail hotel investments in Egypt and Argentina, as well as a women’s garment manufacturer in Sri Lanka and a Chinese auto parts producer. He teaches courses on international business and the global political economy. At the INSEAD campus, in Fontainebleau and Singapore, he has taught European and world politics, markets, and business in the MBA, and PhD programs. He has taught on INSEAD’s flagship Advanced Management Programme for the last three decades, as well as on other Executive Development and Company Specific courses. Jonathan Story works with governments, international organisations and multinational corporations. He is married with four children, and, now, thirteen grandchildren. Besides English, he is fluent in French, German, Spanish, Italian, reads Portuguese and is learning Russian. He has a bass voice, and gives concerts, including Afro-American spirituals, Russian folk, classical opera and oratorio.
This entry was posted in Asia and tagged , , , , . Bookmark the permalink.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.