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Transition 2005 Briefing U.S. Policy Toward Asia in a Second Bush Administration

Speakers: Eric Heginbotham, senior fellow, Asia studies, Council on Foreign Relations, Edward J. Lincoln, senior fellow, Asia and economic studies, Maurice R. Greenberg geoeconomic studies, Council on Foreign Relations, and Adam Segal, senior fellow, Asia studies, Council on Foreign Relations
Presider: Nancy E. Roman, vice president and director, Washington program, Council on Foreign Relations
December 8, 2004
Council on Foreign Relations

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Washington, DC


NANCY ROMAN: I’m Nancy Roman, director of the Washington Program here at the Council on Foreign Relations. Welcome. These lunches are something that Marie [Strauss] and Lisa [Shields] in our communications shop decided would be an important way to engage you and give you some exposure to the scholars and experts at the Council who are doing work in the various regions. Today we’re here to talk about Asia policy in a second Bush administration. I don’t think there’s any region more significant— you know, whether it’s economics, exchange rate, trade, Taiwan, nuclear issues— I mean, across the board. And I’m delighted that we have three of our best people here to take it on. Ed Lincoln, to my left, is our senior fellow for Asian and economic studies. His expertise is Japan, but I like his line about himself, so I’ll steal it. He says like all Japan experts, he’s expanding into other areas in Asia. But he’ll be talking a little bit about trade and the exchange rate. To my right, Eric Heginbotham is a senior fellow in Asia studies. He ran our task force here at the Council on Korea, but his expertise is East Asian political and security affairs. And to his right is Adam Segal, who is the Maurice Greenberg senior fellow in China studies. His expertise is Chinese domestic politics, technology, and technology issues. He’s working on an interesting project for the Council on innovation.

EDWARD LINCOLN: OK. I’ll start with my three to four minutes’ worth. I just thought I’d pick a couple of points on the economic side of things that I think are likely to be important, and then we can talk about it more later. The first one is macroeconomics. As I’m sure all of you in this room know quite well, the U.S. is running a larger and larger current-account deficit. As an economist I will tell you, there is nothing wrong with running a current-account deficit or surplus, so long as all the other macroeconomic variables work out. The concern at the moment is that the United States is running a deficit that may be larger than the rest of the world wants to finance. That will put in train a complex set of adjustments of which exchange rate movements are going to be one part. That has been an issue for the past year. I think it will be a more salient issue over the next several years. Obviously this affects Japan and China, but other Asian countries as well who do not particularly want to see their currencies rise against the dollar and thereby possibly choke off export growth, which, at least for the Japanese in the last couple of years, has been a principal engine of economic growth.

The second point I want to make is about trade. I believe that the Bush administration now is presented with an excellent opportunity to bring the Doha Round of WTO [World Trade Organization] negotiations to a successful conclusion. In the first term they got it started. They accomplished things which the Clinton administration had not been able to accomplish— trade negotiating authority for the president and the start of the round. But here we are kind of stalled halfway through this round. In the last year there’s been a lot of pessimism about it, but I think that’s actually pretty normal for this stage of a big round. If I were in the Bush administration working on trade policy, I would say this is the thing that we can accomplish, and Bush can go out of office saying, “I started it, I got Congress to let me do it, I got it done, and I got Congress to approve it.” That would be quite an accomplishment. However, if the administration goes down this road, they’re going to have to knock heads together, particularly, say, with the Japanese and maybe the Koreans on agricultural issues, with other countries on some other issues to get this done. That will create some sense of tension between the U.S. government and others around the region as this happens.

As kind of an adjunct to that point, one thing that I’m not really going to talk about but we might want to explore later is regional and bilateral trade arrangements. Clearly there has been a quickening process around the region; the Japanese, the Chinese, and others are negotiating bilateral and sub-regional free-trade agreements. The United States is doing the same thing. And so a further question might be how does that mix of bilateral and sub-regional negotiations work out over the next four years? I would guess that some of the energy in that gets sucked out as we turn back to Doha, but there’s a lot more that we could say. And I will just leave it at that.

ERIC HEGINBOTHAM: I think we will certainly cast our net more broadly on Q and A, but I just wanted to make a couple of comments about China’s new diplomacy and some of the issues that it raises for the United States in the region. China has made some fairly dramatic strides internationally over the last several years and continuing, I think, it’s certainly been quite apparent in back-to-back meetings in APEC [Asia-Pacific Economic Cooperation] and the ASEAN [Association of Southeast Asian Nations] Plus Three [the 10 ASEAN nations plus China, Japan, and South Korea]. It’s been quite proactive and aggressive in pursuing its new diplomacy and new diplomatic relationships. Its power and markets obviously give it new entree in places where it previously didn’t have strong relationships.

Probably more importantly, it’s growing more adept at using its assets with greater flexibility and skill, and now pursues public diplomacy in a more systematic way and with greater resources. It’s also increasingly pragmatic in its use of regional fora. It’s involved in literally every important region of the world. And it’s willing to pay economic costs in exchange for cementing its relationship. And increasingly, at least up to a point, it’s willing to make diplomatic and security concessions— or at least compromises in areas where those are issues of concern. The best illustration is probably in China’s backyard, in Southeast Asia, where it’s been playing the game the longest. And all of this, I think, was on display at the latest ASEAN Plus Three meetings last month, where it continued to make progress on this bilateral ASEAN-China free-trade agreement, and I think concluded agreements on dispute mechanisms and some other things, as well as pushing the timetable forward. Part of the agreement always included an early harvest clause, where China would agree to open its markets earlier and faster to ASEAN than ASEAN would be required to open its markets to China. So it is willing to pay a cost. At the same time, at the same set of meetings, it also concluded a code of conduct in the South China Sea on security and military behavior in the South China Sea. It’s not coincidental. These two processes, the free-trade agreement and the code of conduct, have been going together on parallel courses simultaneously over the last two years. It’s also important to note that, in contrast to Japan, which is very reticent to address agricultural issues, as Ed pointed out, China is not. And this is a fully inclusive agreement that includes agriculture.

Also at the meetings a paper was put out by the Joint Study Group of the Plus Three grouping— the South Korea/China/Japan grouping— on investment agreements. And for the first time, the proposal was raised to at least establish a study group on a trilateral— South Korea/China/Japan— free-trade area that had the endorsement of Japanese business leaders for the first time, at least the participants in that study group. That, I think, is a long way from reality and does not share the full endorsement, certainly, of the Japanese business community. But nevertheless, it was broached for the first time at that level.

So all in all, this was a tour de force. It was coming on the heels of another tour de force, which was [Chinese President] Hu Jintao’s performance at [the] APEC [meeting in Santiago, Chile in November 2004]. He showed up seven or 10 days prior to the meetings, toured the region, concluded over $10 billion in agreements with Argentina, for example, which had defaulted on its payments in 2001, has been quite desperate for foreign investment; over $10 billion in deals. Those are likely to go forward since they are pragmatic infrastructure agreements. Is this good or bad? What should we do about it? I think that’s maybe the area for conversation. And I should probably wrap up here.

China challenges the region to freer trade. It’s sort of pushed Japan to react and others to accelerate their time schedules and activity on concluding FCAs [free carrier agreements, a trade term requiring the seller to deliver goods to a named airport, terminal, or other place where the carrier operates]. It’s pretty tough to argue with the growth of free trade, so in that sense it’s a good thing as long as these agreements are consistent with WTO rules. Also, the fact that China is finding success in public diplomacy and soft power is, I think, to some extent shifting how China defines its national interests. And the fact that it’s finding success and the fact that it now senses that it can gain recognition as a constructive member of international society is also probably a good thing. But, certainly, this raises questions. China’s success raises questions about the United States’ role in the region, whether it can remain relevant, whether it can pursue its values in the same way that it did if the centerpiece of regional organization becomes organizations that may increasingly exclude the United States. And then a second issue that I think this raises is how the United States can institutionalize its relations in the region and whether this is not an opportune moment to talk about other additional international security-related fora to capture and incorporate China with a greater role in regional security affairs. With that, I’ll wrap up.

ADAM SEGAL: I’m going to talk briefly about questions of innovation and a kind of a perfect storm of three variables I think is going to happen over the next four years. I’m not sure the Bush administration is going to pay much attention to these variables. There wasn’t much discussion of it in the election. I don’t think the debate on outsourcing really got to our basic problem. But I think they will continually come up. You know, the coverage about Lenovo [China’s biggest maker of personal computers] in purchasing part of IBM, the conflict with China over WI-FI [“wireless fidelity,” wireless Internet access] and WI [wireless technology]. I think that we’re looking at a lot of technology issues over the next four years. I think the first is this pretty fundamental question about how innovative the U.S. is going to continue to be. Here there are questions about spending in basic research. Congress just cut spending for the National Science Foundation. The Defense Department has put more into development than it has into basic R&D [research and development], and industrial funding has been flat the last three years.

And then there’s the question about Americans going into science and the U.S. dependence on foreign students, which in and of itself is not a problem, but if they can’t get into the United States because of visa restrictions or if they’re going to universities in Canada, New Zealand, or Australia, then that, long term, could be a problem for the United States.

The second variable is this rise of innovation in Asia. And here, I think, across the region you see innovation as a national priority. You see all the countries increasing their spending on R&D across the board. And you see very focused spending in nanotech, biotech, and information technology, three areas where the governments of Korea, Japan, and China all think the next wave of innovation is going to be.

But in addition to this top-down focus, which is traditionally how we think of development in Asian states, there is an increasing awareness that Silicon Valley is what drove innovation; that is, small firms, private entrepreneurs, venture capital. And so, all these countries are aggressively trying to recreate that locally. The success has been mixed. It’s hard to have VC [venture capital] when the stock market doesn’t really work, like it does in China, but it’s clear that that’s a goal that they want to go [toward]. If you see the debate about accounting for stock options, you see a lot of the American CEOs say, “Well, look, China’s moving toward stock options, should we be moving away from it?”

Finally, I think you’re beginning to see the Asian market as almost the dominant marketers to technology consumers, especially if we look at the areas where cell phones and information and 3G and 4G [third and fourth generation technology] and all these things are coming together. Numerous consumers are there, people are moving to be close to those consumers, and then you have the markets driving each other. So you have Indian companies looking more at China, not only to service American multinationals there, but also to gain access to the embedded market in China and eventually into Japan. So you have all of these— these three variables that overlap, this kind of perfect storm where I think the next four years, it’s clear that innovation is going to be a more central concern. Congress just extended the R&D credit, but only again for another 18 months. There’s been some discussion— Catherine Mann, for example, at Institute for International Economics— about tax incentives for human capital investments, but I don’t think there’s been broad enough thinking about these issues.

ROMAN: OK, I guess we will throw it open to questions now, questions or comments. Barbara?

QUESTIONER: None of you mentioned North Korea. How important is this? Do we need a settlement [of the north Korean nuclear issue]? Can it go on and on with perhaps a return to the six-party talks? Does it matter?

HEGINBOTHAM: I think when the crisis broke in October of 2002, there was great concern that things could escalate, as in fact they did, and that ultimately this could lead to an armed confrontation, an actual shooting war. Of course, that can’t be dismissed, but I think there’s another scenario here that’s equally worrisome: now that we get a de facto North Korean nuclear regime— they are in fact pursuing a serious production of weapons-usable fissile material, if not the weapons themselves; and that you get de facto acceptance of North Korea as a nuclear state. Now there is quite a bit of disagreement between the key partners on this issue— the United States, South Korea and China; Japan, to some extent, is closer to the United States. But nevertheless, particularly South Korea is out there pursuing a policy that’s radically at odds with the gist of U.S. policy, and has effectively delinked the economic engagement from the nuclear issue. So I think now it will take quite a bit of effort to get us back to a unified position where we have agreement on carrots and sticks that would conditionally be applied. Right now you have South Korea engaging, offering carrots, but with very little conditionality to them. And you have the United States threatening some type of action, or at least pressure, but also again with relatively little conditionality and without offering much tangibly on the table. So I think it’s going to take a while to get everyone back on board and start the process moving again. It looks like there may well be a subsequent round of talks. The United States did put a proposal on the table. There was some progress in the last round. We did have working group meetings going on, which was also progress. But this is going to take a while.

QUESTIONER: Does it matter— [inaudible]?

HEGINBOTHAM: Well, I think there are lots of reasons to be concerned about a nuclear-armed North Korea. It’s an unstable, unpredictable regime. It’s also a regime that may not be around forever, that may, in fact, collapse at some point, although obviously it’s impossible to predict when. So, you know, under those scenarios it’s frightening to think about the prospects of what might happen to the fissile material in those cases. And also, of course, we can’t preclude the possibility that even without a collapse the regime itself might export that material. So yes, it matters in an immediate sense for our security. Also, I think there are a number of troubling scenarios for what might happen, for example, if North Korea goes ahead and tests a nuclear weapon; the types of stresses that that might put on, for example, U.S.-China relations. Then, I think, the United States— there might be a lot of pressure to put China’s feet to the fire on sanctions, and I think this could bring to the fore fundamental disagreements between the United States and China and how we approach North Korea. And of course, if there’s a test, there are also questions about what the other states’ responses might be in terms of their own review of their nuclear options. So Japan and South Korea might increasingly have a discussion of the acquisition of nuclear capability.

ROMAN: Here.

QUESTIONER: On China— [inaudible]--agenda on the world stage and public diplomacy, it’s obvious that it’s being done to be an influence. But do you think that there is a more specific goal of all this? And how do you see the U.S. responding to that, or how should the U.S. respond, if it’s not adequately responding at this time?

HEGINBOTHAM: One of the features of China’s new diplomacy is that it is functionally specific, in a sense. I mean, China used to have an ideologically— or at least more ideologically driven foreign policy. That’s not to say that it was ever divorced from power politics terms, but it was just some unified vision of ideology and power. But now you have China pursuing its foreign policy much more pragmatically, which means it has— rather than a global policy or a third-world policy or even an Africa policy, it now has an energy policy— a policy to develop relationships with key market states so it can develop brand names before making entrees into the first world. It has a Taiwan policy that it pursues with states where there are comparative advantages there. So it’s got a variety of sort of functionally oriented policies.

The United States has not really reacted, certainly in any systematic sense, to this rise in Chinese influence or power. I think there’s quite a bit of disagreement within the United States about what the implications are of that. But I think some of these issues are likely to be higher profile and more contentious in the next couple of years. China’s relationship with Iran is deepening quite rapidly, and also its relations with Sudan are now contentious issues. So throw that in, in addition to pre-existing issues on Taiwan, and I think we’re likely to have some more fundamental discussion about what the U.S. relationship is with China and how it should react.

SEGAL: If I can add to that, you know, I think, in many cases, the policy response of the United States is not necessarily vis-à-vis China, it’s the region. You know, I think there’s a sense in the region that the United States has stepped back and allowed China to take advantage of its absence. And so a kind of re-engagement with Southeast Asia, where the U.S. is not only talking about terrorism, but also engaging on economic issues that seem to have more resonance locally, may be the most effective strategy and at least shape this perception that it’s China that’s coming along and sending this message about all boats rising at the same time.

LINCOLN: If I could just add a sentence to that as well. We’ve seen, actually, a remarkable change in China over the last 15 or so years in terms of a rapidly rising engagement with the world through trade and investment. Today the ratio of exports to GDP [gross domestic product] and the ratio of imports to GDP are both well over 20 percent in China. That’s more than double what they are for Japan. Similarly for investment. The inflow of foreign direct investment is now running somewhere in the order of 15 percent of total capital formation in China. That’s at European levels where there’s lots of cross-border capital flow. So China’s become much more engaged. And I think partly as a result of that, the U.S. government, somewhat to its surprise, has found that China’s public diplomacy on trade issues in the WTO has been much more positive than we anticipated. So I think, for example, we will be looking to them to play something of a leadership role among developing countries in the drive to get the Doha Round finished.

ROMAN: [inaudible]

QUESTIONER: To get back to the current-account deficit, just this week again [U.S. Trade Representative] Robert Zoellick— [inaudible]--a number of administration officials— [inaudible]. This sounds a lot like the period during a similar problem with Japan: Don’t worry about it. It’s fine. The administration— [inaudible] --some experts say the dollar’s been declining; as soon as the administration is re-elected— and, of course, we didn’t do anything about it. [inaudible]

LINCOLN: Well, I assume what he’d be referring to is the previous time with Japan— the first half of the 1980s. The big difference there is that Japan had a floating exchange rate at that time, and what we— and actually there was a lot of anxiety about Japan. The outcome included intense negotiations between the U.S. government and Japan in 1984-85, the so-called yen-dollar talks, to get the Japanese to liberalize their capital markets so that foreign investors would have more incentive to invest in Japan and thereby push the yen up against the dollar. It also involved a rather dramatic G-7 [Group of Seven Industrialized Nations] finance ministers’ meeting in ‘85 for the Plaza Accord [among finance ministers and central bank governors from the United States, Japan, Germany, France, and Britain to weaken the dollar]. Nothing like that is happening this time, so I’m not sure he quite wants to make that comparison. If you look at the crisis before that with Japan, maybe that’s the one we should look at— that’s the crisis that destroyed the Bretton Woods system of fixed exchange rates in 1971— because, after all, China does have an exchange rate that is fixed in dollar terms and it’s becoming increasingly untenable, which is exactly where Japan was in 1971. We made no headway with the Japanese in trying to get them to revalue their currency, and that was a principal cause, if not the principal cause, for President Nixon’s decision in August of ‘71 to cut convertibility of the dollar into gold.

Now we can’t do that with China. If the Chinese want to maintain a fixed currency, that’s their option. We’ve already broken the gold rule, so there’s nothing left we can do on that. But certainly I think we are in a position where the pressure on China to do something, whether that’s to simply change the peg for their dollar— or for their exchange rate against the dollar or to move to some greater flexibility in their exchange rate— I’m not sure how it’ll come out, but that— I think that the pressure to do something will continue to be there and will intensify in the next year or so.

QUESTIONER: And so you’re saying that this administration’s approach is—

LINCOLN: Well, simply to say that it’ll all blow over and don’t worry about it is— I’m guessing that at the moment they’re in a mode where they don’t really want to deal with this issue, so they’re going to kick it down the road a little bit. But it’s going to rise back up for them.

ROMAN: Well, I would just jump in on that very briefly in that, talking to administration officials often in my previous post, where I was with the G-7 Group and advised on these issues, I think the reason Zoellick says that everything will be fine is not because he thinks it’s perfectly analogous to previous points in time, but because the administration really believes that there will be sufficient capital to finance the deficits and that, you know, the overall U.S. economy is attractive enough in terms of a place to invest that it is a sufficient pull, you know, for currency into the United States. I do think behind the scenes a lot of people are arguing to bring the deficits down, but given the challenges of spending you have to consider your alternatives, because this administration doesn’t believe that intervention works— intervention in the currency markets— so they think that that’s sort of jawboning that can affect things at the margins for a few days.

And I think one of the pretty significant developments that’s been underreported is how this Treasury Department has really redefined the dollar policy. Nobody says that, because they still embrace the strong-dollar rhetoric, but really they’ve moved to a flexible-dollar policy. That’s what they believe in, and that’s where they are. I think the confidence they express publicly is mostly felt privately. Of course, there’s a little more angst in private about, you know, what if things don’t go well, but I think they really do believe, you know, capital will flow in. Anyway, yeah?

QUESTIONER: This is a two-part question. Do any of you think that there are security implications for this new deal between the IBM PC operation and this Chinese company? And do you think that this administration has a workable policy for maintaining a balance between China and Taiwan?

ROMAN: Adam, the security piece of that sounds like you, and Taiwan, Eric.

SEGAL: Yeah. I don’t think there are any clear security implications. You know, the purchase seems to be only of the PC sector. Lenovo already makes PCs. It’s not gaining any access to any technology that it didn’t already have access to. What it’s gaining access to is the brand of IBM, some management skills, probably distribution and networking. So it’s not really a question of technology and security; it’s more a question about global branding.

HEGINBOTHAM: On the Taiwan question, I do think it’s certainly a dangerous situation, largely because it’s out of our hands. I think the administration does realize now how dangerous the situation is, and it is going to do all that it can, has done all that it can, to make clear to the Chinese side that whatever Taiwan does and [Taiwanese President] Chen Shui-bian does, he does on his own. There are tensions here, of course, in the administration’s policy in that, under their tenure, the United States has approved a wide range of new types of arms sales to Taiwan. So we’re vulnerable to accusations on that side. But nevertheless, diplomatically the administration is making quite clear to Taiwan that it doesn’t support any new moves towards sovereignty— really almost in any form. So I think we’re trying to make clear to the Chinese side that whatever it does it does on its own. Nevertheless, it is quite worrisome, not just because Chen Shui-bian has sort of gamed the system— using the referendum, for example— in political ways, but also because I think China now has gotten fed up with Chen Shui-bian gaming the system and is now doing some of its own gaming. In a way it’s playing a game of chicken here by talking about passing legislation that will effectively take the steering wheel and throw it out the window. That will require China to take certain actions if Taiwan takes certain actions, which I think is extraordinarily worrisome. So there’s certainly cause for concern. The administration’s doing what it can to distance itself, to remove itself from that, but I think if there is a crisis, the United States is quite likely to get sucked in, regardless of what it does.

SEGAL: And I would just reinforce what Eric just said. I think if you look this last week in the run-up to the elections, I think the administration has been very consistent about the message it’s been sending to Taiwan and to President Chen about President Chen maintaining the “ five no’s” and not changing the name. But as Eric said, it’s very much out of the administration’s hand, other than maintaining a consistent message and ensuring that Taiwan’s defense is adequately prepared for under the Taiwan Relations Act. You know, it’s really President Chen who I think drives things.

QUESTIONER: Can I follow up on this just very briefly? What do you think the impact would be if the EU [European Union] went ahead and lifted the arms embargo on China?

SEGAL: I think it would be very bad. [Laughter] You know, I think it’s clear that it’s bad in a number of ways. I think, one, the United States does not want China to have some of the capacities that NATO [North Atlantic Treaty Organization] could sell it. I think it’s just clear that there are real concerns about air or sea or integration capabilities that they can get from NATO that would significantly strengthen their coercion effects on Taiwan. I think the second is— you know, it’s kind of symbolic of the split between the EU and the U.S. on a range of issues. But pretty much, the EU is saying to the United States, “We don’t really take the coercive threat seriously against Taiwan. We don’t really think it’s that big a deal.” And I think it’s clear the United States takes it very seriously. And so a failure to convince the EU that the United States is going to be put in this position, I think, would be a pretty bad move forward.

QUESTIONER: Eric, can you elaborate a little bit as to what you mean when you say, you know, whatever Taiwan does Taiwan does it on its own? Does that mean that the— [inaudible]--crisis, especially if the crisis is provoked by the Chen Shui-bian government, the U.S. will keep its hand off?

HEGINBOTHAM: No, I don’t, actually. [Laughter] And what worries me is that— the administration has been very consistent. It’s been very clear. It’s been very forceful. But if a crisis happens, it’s unlikely to be a one-step crisis where Taiwan takes some action and then there’s a war. You know, there’s going to be some escalatory sequence, and it’s going to be difficult at the end of the day to untangle exactly who was responsible. And even if Taiwan begins the sequence, and even if Taiwan shares or really holds the bulk of the responsibility for it, I think, politically in the United States, it may not be seen that way. It’s going to be extraordinarily difficult for the United States to stay out of. I think the U.S. will get sucked into almost any crisis that’s imaginable.

QUESTIONER: May I have a follow-on, please? You know, recently President Bush met with President Hu, and President Hu particularly called on President Bush to sort of— although he didn’t exactly use those words, almost like forming a united front trying to stop this Taiwan independence thing. Obviously, this is quite a shift from his previous policy, because in the past China always said Taiwan is a domestic issue, it brooks no foreign interference; now we hear the president of China calling on the United States, looking for help. This is, as far as I’m concerned, quite significant. Do you foresee down the road that the United States, especially if and when U.S. interests are adversely affected by this Taiwan push for independence, that it will really team up with China trying to stop the independence thing from Taiwan?

HEGINBOTHAM: It’s interesting. I think it’s also significant that Hu used this language, made this approach. The Chinese leadership, the civilian leadership, is as worried about this issue, obviously, as the United States is. They have been quite flexible. If you were looking at this situation 10 years ago and you were to have said that Taiwan would take this, that, and the other step, the steps that in fact they have taken, one might have predicted a war. China, in a sense, has backed away from certain red lines over time. You know, a war with Taiwan, even if it didn’t involve the United States, in a certain sense, if it weren’t suicidal, it would certainly be playing with fire. The last thing the leadership wants is conflict with Taiwan. So I think there are serious common interests now with the United States in avoiding tensions on this.

SEGAL: Remember the United States issued to Taiwan the “Six Assurances,” so it’s rather limited how far the United States could go. And I would read Hu’s warning or Hu’s calling on Bush to play more of a role as not entirely about Bush playing a role, but Bush sending a message throughout his government. I think part of what Beijing believes is that either Bush isn’t consistently identified with the policy that Beijing wants, or Bush has a problem making sure that the same message is consistently given; that maybe Defense is saying something different to Taiwan than State is saying. So I think it’s very possible that what Hu really wants from Bush is saying you should speak in one voice and make sure that you speak in one voice.

HEGINBOTHAM: There were serious discipline issues during the first term that I think have been addressed, largely addressed.

ROMAN: We’ve got one, two, three.

QUESTIONER: [inaudible]

SEGAL: I’m sorry. I don’t understand the question. Is there a Tibetan factor in—

QUESTIONER: In Chinese— [inaudible] .

HEGINBOTHAM: Are you asking whether Taiwan might be viewed as a precedent—

QUESTIONER: Yes.

HEGINBOTHAM: --for what might happen domestically?

QUESTIONER: [inaudible]--from China.

HEGINBOTHAM: You know, I would— I don’t know. I haven’t thought about it. But I’ll answer anyway. I think it’s reflective of two things. One is, I think it’s clear, you know, in the Chinese mind that we’re talking about dominoes, right? So they’re all connected. It’s domestic dominoes. If Taiwan isn’t a part of China, then it would be very easy for someone to argue that [the Muslim-dominated Chinese province of] Xinjiang and Tibet aren’t. So you want— if you’re worried about splitism, then you’re going to make sure that the message is the same across the board.

The second, I would just guess, perhaps, is that I don’t— you know, Beijing, it’s clear, is not all that serious about negotiating with the Dalai Lama right now. If you come up with more conditions for him— it seems to me the strategy is to wait until he passes from the scene anyway, so maybe you just come up with more conditions and throw more roadblocks at the negotiation.

QUESTIONER: [inaudible]

HEGINBOTHAM: I think [Secretary of State-designate Condoleezza] Rice understands that— I don’t foresee a radical shift on Korea policy. I think now there’s broad consensus— maybe it’s the least common denominator consensus— that this needs to be resolved diplomatically, that there really aren’t military options. I’m not sure politically that Bush wants to make this type of issue the centerpiece of his second administration. He may want this to go away. That said, I would imagine there may be renewed effort to apply pressure and to get a consistent, coherent Korea policy back together and to apply new pressure on North Korea. I’m not sure, though, where the possibilities lie in that regard. I mean, we may try to invigorate the PSI [Proliferation Security Initiative], but really it has relatively little support in the region. You know, at least as far as aggressive application is concerned to North Korea, the South Koreans are dead set against it. The Chinese are basically against it. So I’m not sure what the avenues are to apply additional pressure. Well, we put more pressure on China to do more, but China is our intermediary. We depend on China to get North Korea to the table. So they have to play a very delicate game. So I’m not sure where our avenues are for increased pressure.

You know, as I said, I think the promising development from the last set of six-party talks [on the North Korean nuclear issue] that took place were the working group meetings. That allows much greater room for floating proposals at a lower level, which would obviously make their way up to [North Korean leader] Kim Jong Il and back and again through the U.S. administration. So I think there’s new— you know, there is actually a real dialogue here as far as a search for some middle ground there, I mean, assuming we can get another set of six-party talks and another set of preliminary working group meetings. So there are some hopes there, but I don’t foresee a radical shift on current policy. The question is whether it has any traction or not.

QUESTIONER: So you don’t really— [inaudible]

HEGINBOTHAM: I think it’ll try to re-energize the regional framework, and I think there’s a pretty good understanding now that there’s not a lot of support for really tough measures.

QUESTIONER: Including— [inaudible].

HEGINBOTHAM: The South Koreans simply are not on board for it, and nor are the Chinese. So barring a— [inaudible]--I think it’s tough to envision a real departure on policy.

QUESTIONER: Can I follow up on just the North Korean issues just quickly?

HEGINBOTHAM: Sure.

QUESTIONER: So you can say there is no possibility that this administration’s [inaudible] will shift the policy, you know, from pursuing the peaceful— a peaceful solution to a de facto acceptance of the de facto nuclear state of North Korea?

HEGINBOTHAM: Well, it can’t possibly accept North Korea as a nuclear state. But North Korea is in a pretty good negotiating position right now. In fact, it’s in a pretty good position, period, even without negotiations. I guess that’s the point here, is that they have a nuclear weapon, they have a nuclear deterrent. You know, they have serious production of nuclear weapons or nuclear material, and they haven’t really be threatened with economic collapse. Which isn’t to say that it won’t happen, but they took the first step to economic reform in the summer of 2002. You know, those steps were pretty shaky and actually had some very negative fallout, but they’ve made adjustments since then. They are getting some increased investment from South Korea now, and they’re about to open— well, they are open— are in the process of opening the Kaesong zone [in North Korea, just north of the demilitarized zone]. Rail links and road links, now temporary but soon to be permanent, have been established. So from their perspective, they’ve made some forward progress economically or certainly they haven’t been threatened with imminent collapse, and they have a nuclear deterrent. So they’re in a pretty good position. But the administration can’t possibly just accept it, so I think it will continue to pursue the six-party route. And the question is whether there’s common ground there for some kind of ultimate agreement, or at least a partial agreement; you know, the first stage of an agreement which would be a freeze on the North Korean nuclear programs.

QUESTIONER: Also, if it’s possible, could you give me a kind of economic analysis? You know, this problem has come up over two years ago when they said clearly that they have a nuclear deterrence capability. So they declared it’s almost a de facto nuclear state. But could you give me a kind of, this two years’ term, you know, economic analysis? I mean, what kind of an economic dynamism was put on the entire economic situation in the Asia region? It’s a kind of negative, or— you know, of course it’s a negative.

HEGINBOTHAM: Oh, you mean the economic impact that—

QUESTIONER: Yeah, economic impact on --

HEGINBOTHAM: Yeah, I mean, very little since North Korea is not integrated with the regional economy. I mean, it precludes things like oil pipelines going through North Korea. But actually, you know, I’ve talked to officials in oil companies and they’re not going to do that anyway because you get the guy in the mountains turning it off up there. So I’d say it’s had very little to no impact on the regional economy. I mean, there may be some impact on the perception of South Korea as an investment area, and I suppose if the crisis got worse— if there were nuclear tests and a major escalation of the crisis— it could affect, you know, China as a location for FDI [foreign direct investment]. But to this point I’d say minimal to no impact, really.

ROMAN: Ed, did you want to add?

LINCOLN: Well, just to reinforce that, certainly I have never heard any American businessmen or investment bankers talking about increased risk in Northeast Asia due to the possibility of some blowup of problems with North Korea. So again, I would say it hasn’t been a factor.

ROMAN: OK.

QUESTIONER: I have some follow-ups on the North Korean issues, especially with regard to the Japanese approach towards North Korea, because today there was news in Tokyo that the Japanese government announced that one of the bones of an abductee [Japanese citizen abducted by North Korea] is identified and it’s not hers, actually; it’s someone else’s. So it’s a big criticism among the public opinion towards North Korea’s response. And it’s a very humanitarian issue and sensitive issue, so people are talking about sanctioning them or, you know, some tougher position. So when you talk about how it’s important to have a unified position among the six parties, at the same time, the Japanese position is leaning towards rather hawkish right now. So do you think it’s appropriate for moving the process forward, or do you think it’s better to have other options?

ROMAN: I think that’s for you, Ed.

LINCOLN: One of the things that I find interesting about this is that if you discuss the North Korea issue in Washington in almost any forum, the abductee issue is not mentioned. OK, because in the larger scheme of things it’s not important. Plus, it wasn’t Americans who got abducted. [Laughter] But frankly, you know, I hate— I hate to sound inconsiderate, but, you know, the difference between 12 people who got abducted 25 years ago versus nuclear weapons that might cause hundreds of thousands of lives to be lost, they’re just not in the same category. And so from a Washington perspective, the abductee issue just isn’t there. If you go to Tokyo, of course, that’s all anybody talks about, because it is very personal, very emotional; it’s a humanitarian issue. And clearly, there is a process of continued North Korean obstruction on coming clean with what happened.

The bottom line, though, for me is that at some point, I think the Japanese government and Japanese society has just got to get over that. The comparison, I think, is to the American MIA [missing in action] issue in Vietnam. Have we ever gotten a full accounting of every missing American in Vietnam? No. Are we going to get it? No. Is the Vietnamese government cooperative? Much more than they used to be, but, you know, there are limits on how far it can go. And at some point, you have to have a government that can say our broader interest dictates moving on and dropping this issue. And so I get a little concerned that the Japanese government actually appears to be moving the other way, and instead of playing it down is playing it up and, therefore, moving to, as you say, apparently, some rumors that they might even consider favoring economic sanctions on North Korea. I’m not quite sure what the point is, if that’s really the motive for doing it.

QUESTIONER: My real question is not about the Japanese reaction, but to have a tougher position towards North Korea by Japan, would it be appropriate for the United States?

LINCOLN: Well, I’ll leave that up to Eric.

HEGINBOTHAM: Yeah, I mean, of the three relevant countries— Japan, South Korea, and China— Japan has clearly taken the toughest stance. I mean, they have cut off a good proportion— no one knows exactly what percentage— of the funds that were flowing from North Koreans [living in Japan] to the [North Korean] regime. You know, they have actually pursued a variety of laws that make it quite difficult for North Korea to continue to trade with Japan. So I think they have been on board with the idea of applying pressure on North Korea. They hosted the latest PSI exercises, and you had [Under Secretary of State for Arms Control and International Security] John Bolton standing on the deck of the cutter with his sword out. [Laughter]

And, I mean, any solution is going to require carrots and sticks conditionally applied. And so, you know, if we could get South Korea and China on board for some type of conditional sanctions regime, that would be important. It will also require flexibility in negotiating positions and some carrots. So I think it’s important, but, you know, we’ve got a long way to go, and the key thing is to get South Korea and China on board with a unified policy.

ROMAN: [inaudible]

QUESTIONER: Still on North Korea. [Laughter] I understand that we don’t know when the next session of the six-party talks is scheduled. I’m wondering whether the United States should— [inaudible]?

HEGINBOTHAM: I guess there are two issues. One is the deadline for actually having the meetings, and the other is the deadline for some kind of an agreement. Right now I really look at this as a hiatus, basically. The last sort of scheduled September round was cancelled in light of the [U.S.] elections. I think quite clearly North Korea wanted to wait and see who was elected, and they wanted to deal with the Kerry administration rather than with the Bush administration. And now, of course, we have new leadership in the State Department, and the United States is going to have to— may take a little while to get its team together and get its position on the issue together. But we have continued to engage China on this, and I think China is beginning to move to get the next set of six-party talks together.

I think it will be fairly clear over the next month or two whether we’re going to have them. I would guess that we probably are going to have them. The bigger question is whether we make progress. And again, I think we were making some progress, very, very, very far away from an agreement, but it will be interesting to see what happens at the next— but both sides presented proposals, both sides said that there were issues with them that made the other side’s proposals unacceptable, but both sides actually said there were some common areas of, at least, agreement in principle, and that both sides would go back and study the proposal of the other.

QUESTIONER: [inaudible]

HEGINBOTHAM: We’re spending a lot of time on Korea today. One does certainly get the sense that the first order of business— obviously, the big issue is North Korea, but the first order of business is South Korea. I’ve heard administration officials who will go unnamed saying, “OK, we’re going to go over there and win hearts and minds.” And by that he was talking about South Korea, not North Korea. You know, we are worlds apart right now. I understand that [South Korean] President Roh [Moo-hyun]’s comments in Los Angeles, I believe, that that speech was not carefully vetted, part of that speech, including that portion of it where he said that the North Korean nuclear program was, in part, defensive, or at least they viewed it as a defensive effort. I believe that was not carefully vetted. The administration here decided not to make a huge issue of it. They were quite disturbed by it. I think this has spillover effects. You know, the administration denies it, but I think— you know, I think this does have an impact when we talk about military restructuring in the region and how we think about our alliances— the roles of our various alliances. I think the— you know, officials in the United States— not necessarily with this administration, but with the bureaucracy and other specialists in the area— may think of Japan now as a sort of a global partner, but may think of Korea in quite different terms. So I think this really does raise serious issues.

The causes, of course, go back decades, and there’s a lack of really aggressive public diplomacy and fundamental dialogue about where the alliance is headed and what the purpose of the alliance is. And I think we are engaging on some of those issues now. You know, it’s been a long time coming and it’s quite late, but I think there are real questions. There are some homeostatic kinds of self-regulating mechanisms here. I think at a certain point if the United States is making sound like it might leave entirely, the China issue will certainly loom large in Korea. So I think there’s some self-regulating mechanism here, but there are also serious questions.

ROMAN: OK. We have a question here and we have 15 minutes, so it would be good if we can move off Korea, I think. Are you on Korea?

QUESTIONER: No.

ROMAN: Oh, good. [Laughter]

QUESTIONER: I apologize. I was very late, so you may have covered much of this. But one of the most important and largely unremarked events of the last four years has been the growing economic interdependence of the United States and China. I mean, it’s one of the most extraordinary— [inaudible]--four or five years, extraordinary shift. I wonder to what extent, especially from the U.S. side and certainly from the Chinese side— to what extent is U.S. dependence on— on China continuing to buy U.S. treasuries and essentially continuing to finance U.S. borrowing habits, to what extent is that having a broader effect on the U.S. policy towards China? You know, in the past, on the situation with Japan— it was a similar situation we had with Japan— there was the constant fear and the constant threat all the time that whenever things got bad, including the relationship, perhaps the Japanese would sell all their U.S. treasuries. Every time there was some tension on the trade issue, for example, there were rumors that that’s what Japan was doing. But the dog didn’t bark. But the stakes are now much higher. The relationship is much more complex than it ever was with Japan, where there was a relatively simple political and economic relationship. To what extent is broader U.S. policy towards China now being affected by this extraordinary, I mean quite unprecedented, degree of dependence that the U.S. now has on China’s financial support?

LINCOLN: None.

QUESTIONER: None at all? [inaudible]

LINCOLN: First of all, sure, we are more dependent on financing of the federal deficit by China than we were 10 years ago, when it was presumably zero, but you know, even whatever it is that the central bank holds now, five [hundred billion] or $600 billion, that’s not a lot. And the more important point, I think, is that the experience of American government officials coming out of the 1980s and ‘90s was the realization that those fears that were expressed— predominantly outside of government, not inside the government— that the Japanese might use their leverage by ownership of federal debt to affect our policy on various trade issues, which was the issue of the moment back in the ‘80s, turned out to be wrong and is wrong for a very important reason. And the reason is that, in the case of the Japanese central bank and now the Chinese central bank, the reason they have been purchasing U.S. debt is because they wanted to prevent their currencies from going up against the dollar. Therefore, it would take a fairly extraordinary change in policy position for that same government to say, “we now value our leverage on this political issue more than we value our effort to keep the exchange rate from going up,” and I don’t see any evidence that that kind of a change is likely, either in Japan or China. If China sold off a large chunk of its dollar holdings, they really would be forced to revalue their currency. They don’t want to do that. So that’s one thing I think that affected American officials.

A second thing that affected American officials was a realization that American capital markets are so broad and so deep that if the Japanese central bank or the Chinese central bank chose to dump, say, $100 billion of U.S. treasuries, there would probably be no more than a hiccup in global financial markets, and probably no more than a hiccup in U.S. interest rates, and very short-lived at that.

SEGAL: Ed’s an economist and I’m a political scientist, so I will disagree. [Laughter] I’ll say Ed’s picture is right at the very top levels, but there are plenty of people right now who see the relationship entirely as one of dependence and leverage. And they may be, you know, somewhere in the bowels of the Pentagon or they may be, you know, at NDU [National Defense University] or someplace, but they are seriously thinking about economic leverage, economic statecraft— however you want to put it. You can’t really have a discussion now these days without somebody— you know, before who would only be talking about the renminbi [Chinese currency] or the kilo or something— would talk about dumping Treasury bills. I mean, this may all be untrue for all the reasons that Ed just said. Economically it makes no sense, but political scientists don’t think like economists, and it’s clear that the people that worry about these things, you know, think about it in the terms of leverage. You know, what influence it has at the upper level, I think Ed’s right; I don’t think people think that way at the top level. But—

ROMAN: Does that do it for you, or did you want to follow up? OK. We had some other questions over here I think. Any non-Korea question? [Laughter]

QUESTIONER: My question is not about Korea. It’s about the economy and— [inaudible]. The first one way is about renminbi. Several years ago people were talking about the value of the renminbi probably going down because [there was such a] huge amount of bad loans in the Chinese banking system. And now we are talking about the renminbi possibly going up and the bad loan actually— [inaudible]. And so my question is, on the whole, do you think the value of renminbi is overvalued or undervalued or just about right? And what is the political pressure or popular pressure for renminbi to go up in this country in the next year or so?

And the second question is about relations between China and the United States on trade and economy. There is a school of thought that believes that the two regions are going in opposite directions. [inaudible] On the security issues the two countries are cooperating with each other more and more. On economic and trade issues [there are] more frictions and more conflicts, and those things are now more in the press, and especially when China is developing its relationship with Latin American countries, especially during the APEC conference in Chile, and also China is doing great efforts concerning the Asian— [inaudible]. So what do you think about the relationship on trade and economy between the two sides? Is it really going from better to worse? What is your take on that?

LINCOLN: Well, let me start with the renminbi. The fundamental story here is one of macroeconomic balances. And the position that China has been in for the past 20 years or so, and seems likely to continue for some time, is very rapid economic growth. That requires a very rapid expansion of domestic fixed investment to build the productive capacity to create more output. And that investment in countries like China that are growing very rapidly is usually so large that it simply absorbs all of the domestic savings available to finance the investment. All right? Japan went through this from roughly 1950 to the mid-1970s. China’s going through it now. Therefore, it does seem a little odd if you end up in a position where a country like China is not absorbing all of those savings at home in the form of domestic investment, but ends up with a net capital outflow to the rest of the world. In China’s case, this net capital outflow is in the form of the government intervening in the exchange market.

And so I would say, as an economist, simply from the perspective of what’s good for China that, yes, you probably should revalue the renminbi modestly, so that you’re more back at an equilibrium with the outside world, with a zero current-account balance and a zero net capital outflow, because you need the money at home. How much of a revaluation does that entail? I don’t follow this issue very closely, but I think I’d be inclined to agree with someone like Nick Lardy, who would, say, put it in the range of a 20 percent up valuation against the U.S. dollar.

On your second question, are we moving toward greater tension in bilateral relations on economic issues, I guess my answer would be yes, but it’s certainly not going to get out of control. We are now entering a phase somewhat similar to what occurred between the United States and Japan from the early 1960s through the 1980s— a little bit more clear-cut at the moment with China— where China has joined the WTO, it has obligations stemming from the commitments it made as the admissions price to the WTO, but those obligations are not being fully carried out by the Chinese government. Getting that to happen may take us 10 or 15 years. I do believe that there is recognition in the U.S. government and also the Japanese government and European governments that there’s a limit to how quickly and how forcefully we can proceed on these issues, as there was in the past in the case of Japan; that we don’t want to push so fast and so hard that there is a political backlash in China, saying, “Well, you know, we’re just fed up with this, and we’re going to pull back out of the WTO.” Nobody wants that to happen. But certainly a rather observable level of pressure will have to be there to achieve full enforcement of existing obligations. And that’s going to go on for a while.

On the other things, ASEAN Plus One, ASEAN Plus Three, frankly, I don’t think that this administration is inclined to worry about that very much, because we’re doing the same thing. So China’s interested in a deal with Brazil. Well, so are we. Are these competitive deals? Not really. China wants to import soybeans, does import soybeans from Brazil. We don’t. So I don’t sense a lot of tension coming down the road in that sense. If the U.S. government thought that East Asia was coalescing into some kind of an economic bloc that would seriously disadvantage American firms, then their attitude would be quite different. But I don’t perceive that officials believe that that’s happening. There— yes, there’s a movement toward free-trade areas in East Asia, but it certainly doesn’t resemble any kind of a movement toward a cohesive bloc, and we’re busily trying to negotiate our way in with various countries, like Thailand, to make sure that we’re on the inside as well.

ROMAN: OK. I have time for one last question here.

QUESTIONER: OK. My question is, has the emergence of technology clusters in Asia provided the United States with opportunities or a threat? To what extent will it help U.S. high-tech exports, or to what extent will it damage U.S. dominance in technology?

SEGAL: Here’s a very unsatisfactory answer: both. It’s clear that the U.S.--U.S. companies are advantaged by tech clusters. They find not only cheap land and cheap labor, but also skilled and talented people to do R&D at a cheaper [inaudible]. They can innovate closer to newer markets. This is good for U.S. companies. In the end, it’s good for the U.S. economy. The question is about what that does to the American economy at home. If U.S. companies are significantly— relocating significant parts of the U.S. infrastructure over to Asia, it may be good for U.S. companies. I don’t think it’s good long term for American innovation. So the control of this sort of— if you think of these as networks that span from Asia to China to India and throughout East Asia, where are the most benefits being created, where are the most spin-offs occurring, I think now it’s still in the United States. But if that changes significantly, then long term it would be a threat to the United States.

ROMAN: OK. Just very briefly, Adam, since we didn’t get to as many of your issues as I’d hoped— Adam’s doing some very interesting work on innovation— maybe we’ll just close with you taking two minutes to describe what you’re doing. And we will end right on time at 2:00, as is our tradition.

SEGAL: Well, the Council is just about to start a project on— actually these questions on innovation in Asia, the emergence of technology clusters not only in China but in India, in Southeast Asia. And so this question about if it’s good for the U.S. economy or if it’s bad....

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