Any discussion of the future has to begin with a discussion of China. One-quarter of the world lives in China, and there has been a great deal of discussion of China as a future global power. Its economy has been surging dramatically in the past thirty years, and it is certainly a significant power. But thirty years of growth does not mean unending growth. It means that the probability of China continuing to grow at this rate is diminishing. And in the case of China, slower growth means sub­stantial social and political problems. I don’ t share the view that China is go­ing to be a major world power. I don’ t even believe it will hold together as a unified country. But I do agree that we can’ t discuss the future without first discussing China.

China’ s geography makes it unlikely that it will become an active fault line. If it were to become an area of conflict, it would be less China striking out than China becoming the victim of others taking advantage of its weakness. China’ s economy is not nearly as robust as it might seem, and its political stability, which depends heavily on continuing rapid growth, is even more precarious. China is important, however, because it appears to be the most likely global challenger in the near term—at least in the minds of others.

Again, using geopolitics as our framework, we will begin by considering the basics.

First, China is an island. It is obviously not surrounded by water, but it is surrounded by impassable terrain and wastelands that effectively isolate it from the rest of the world (see map below).

To China’s north are Siberia and the Mongolian steppe—inhospitable, lightly settled, and difficult to traverse. To the southwest are the impassable Himalayas. The southern border with Myanmar, Laos, and Vietnam is simultaneously mountains and jungle, and to the east are oceans. Only its western border with Kazakhstan can be traveled by large numbers of people, but there too, movement involves a level of effort not frequently justified in Chinese history.

The vast majority of China’s population lives within one thousand miles of the coast, populating the eastern third of the country, with the other two-thirds being quite underpopulated (see map, page 90).

China was completely conquered only once—by the Mongols in the twelfth century—and it has rarely extended its power beyond its present borders. China is not historically aggressive and has only intermittently involved itself with the rest of the world. It must be remembered that China
has not always engaged in international trade, periodically closing itself off and avoiding contact with foreigners. When it does engage in trade, it does so using overland routes like the Silk Road through Central Asia and merchant ships sailing from its eastern ports (see map, page 91). The Europeans encountered a China in the mid- nineteenth century that was going through one of its isolationist periods. It was united but relatively poor. The Europeans forced their way in, engaging coastal China in intense trade. This had two effects. The first was the dramatic increase in wealth in the coastal areas that were engaged in trade. The second was the massive increase in inequality between China’s coast and the poor interior regions. This disparity also led to the weakening of the central government’s control over the coastal regions, and to increased instability and chaos. The coastal regions preferred close ties to (and even domination by) the Europeans.

The period of chaos lasted from the mid- nineteenth century until the Communists took power in 1949. Mao had tried to foment a revolution in coastal cities like Shanghai. Having failed, he took the famous long march into the interior, where he raised an army of poor peasants, fought a civil war, and retook the coast. He then returned China to its pre-European enclosure. From 1949 until Mao’s death, China was united and dominated by a strong government, but was isolated and poor.

CHINA’S GAMBLE

Mao’s death led his successors to try once more for the historic Chinese dream. They wanted a China that was wealthy from international trade but united under a single powerful government. Deng Xiaoping, Mao’s successor, knew that China could not remain isolated permanently and still be secure. Someone would take advantage of China’s economic weakness. Deng therefore gambled. He bet that this time China could open its borders, engage in international trade, and not be torn apart by internal conflict.

The coastal regions again became prosperous and closely tied to outside powers. Inexpensive products and trade produced wealth for the great coastal cities like Shanghai, but the interior remained impoverished. Ten­sions between the coast and the interior increased, but the Chinese govern­ment maintained its balance and Beijing continued to rule, without losing control of any of the regions and without having to risk generating revolt by being excessively repressive.

This has gone on for about thirty years, which is not very long by any standard (and certainly not by Chinese ones). The open question is whether the internal forces building up in China can be managed. And this is the point at which we begin our analysis of China and its effect on the international system in the twenty- first century. Will China remain part of the global trading system? And if it does, will it disintegrate again?

China is gambling at the beginning of the twenty- first century that it can carry out an indefinite balancing act. The assumption is that it will be able to gradually shift resources away from the wealthier coastal regions toward the interior without meeting resistance from the coast and with­out encountering restlessness in the interior. Beijing wants to keep the various parts of China happy and is doing everything in its power to achieve that end.

Underlying this is another serious, and more threatening, problem. China appears to be a capitalist country with private property, banks, and all the other accoutrements of capitalism. But it is not truly capitalist in the sense that the markets do not determine capital allocation. Who you know counts for much more than whether you have a good business plan. Between Asian systems of family and social ties and the communist systems of political re­lationships, loans have been given out for a host of reasons, none of them having much to do with the merits of the business. As a result, not surprisingly, a remarkably large number of these loans have gone bad—“ nonperforming,” in the jargon of banking. The amount is estimated at somewhere between $600 billion and $900 billion, or between a quarter and a third of China’s GDP , a staggering amount.

These bad debts are being managed through very high growth rates driven by low- cost exports. The world has a huge appetite for cheap exports, and the cash coming in from them keeps businesses with huge debts afloat. But the lower China sets its prices, the less profit there is in them. Profitless exports drive a giant churning of the economic engine without actually get­ting it anywhere. Think of it as a business that makes money by selling products at or below cost. A huge amount of cash flows into the business, but it flows out just as fast.

This has been an ongoing issue in East Asia, and the example of Japan is instructive. Japan during the 1980s was seen as an economic superpower. It was devastating American businesses—MBAs were being taught to learn from the Japanese and emulate their business practices. Certainly Japan was growing extremely rapidly, but its rapid growth had less to do with manage­ment than with Japan’s banking system.

Japanese banks, under government regulation, paid extremely low inter­est rates on money deposited by ordinary Japanese. Under the various laws, the only option for most Japanese was to put money into Japan’s post office, which doubled as a bank. The post office paid minimal interest rates. The government turned around and lent this money to Japan’s largest banks, again at interest rates well below international levels. These banks lent it again cheaply to businesses with which they were linked, so Sumitomo Bank loaned the money to Sumitomo Chemical. While American companies were borrowing money at double- digit rates in the 1970s, Japanese companies were borrowing money at a fraction of that amount.

It was no surprise that Japanese businesses did better than American ones. The cost of money was much lower. It is also no surprise that the Japanese had extremely high savings rates. Japan had virtually no public re­tirement plan at the time, and corporate pensions were minimal. Japanese planned for retirement through savings. They weren’ t more frugal, just more desperate. And this pool of desperate depositors had no alternative but to make deposits at very low interest rates.

While high interest rates imposed discipline on Western economies, culling out the weaker companies, Japanese banks were lending money at artificially low rates to friendly corporations. No real market existed. Money was flowing and relationships were the key. As a result, a lot of bad loans were made.

The primary means of financing in Japan was not raising equity in the stock market. It was borrowing money from banks. Boards of directors consisted of company employees and bankers who were not interested in profits nearly as much as they were in cash flow that would keep their companies afloat and pay off their debts. So Japan had one of the lowest rates of return on capital in the industrialized world. But it had a fabulous growth rate in terms of size because of the way the Japanese structured their economy. They lived by exporting.

The Japanese had to. With an extremely high savings rate driving the system, average Japanese citizens were not spending money, and therefore Japan could not build the economy on domestic demand. And since Japanese companies were controlled not by investors but by insiders and bankers, what they wanted to do was increase the cash coming in. How much, if any, profit was generated mattered less. Therefore, low- cost exports surged. More money was lent, more cash was needed, and more exports were sent out. The economy grew. But underneath it, a crisis was brewing.

The casual ways in which Japanese banks made loans increased the number of nonperforming loans—loans that were not being repaid. A lot of bad ideas were funded. Rather than write these off and let the businesses in­volved go into bankruptcy, Japanese banks covered up with more loans to keep the companies alive. Loans surged, and since depositors’ money was spent maintaining the system, exports to bring in even more money were es­sential. The system was awash with money, but underneath it a vast array of companies on life support—and companies struggling to increase cash without regard for profit—were undermining the entire financial system. Massive surges in exports were producing very little profit. The entire system was churning just to keep itself afloat.

From the outside, Japan was surging, taking over markets with incredible products at cheap prices. It was not obsessed with profits like American firms were, and the Japanese appeared to have a hammerlock on the future. In fact, the opposite was true. Japan was living off a legacy of cheap, government-controlled money, and low prices were a desperate attempt to keep the cash coming in so the banking system would hold together.

In the end, the debt structure grew too massive and it became impossible to stay in front of it with exports. Japanese banks began to collapse and were bailed out by the government. Instead of permitting a massive recession to impose discipline, Japan used various salvaging means to put off extreme pain in return for a long-term malaise that is still lingering. Growth plunged, markets plunged. Interestingly, while the crisis hit in the early 1990s, many Westerners did not notice that the Japanese economy had failed until years later. They were still talking about the Japanese economic miracle in the mid-1990s.

How is this relevant to China? China is Japan on steroids. It is not only an Asian state that values social relations above economic discipline but a communist state that allocates money politically and manipulates economic data. It is also a state in which equity holders—demanding profits—are less important than bankers and government officials, who demand cash. Both economies rely heavily on exports, both have staggeringly high growth rates, and both face collapse when the growth rate begins even to barely slow. Japan’s bad debt rate around 1990 was, by my estimate, about 20 percent of GDP . China’s, under the most conservative estimate, is about 25 percent—and I would argue the number is closer to 40 percent. But even 25 percent is staggeringly high.

China’s economy appears healthy and vibrant, and if you look only at how fast the economy is growing, it is breathtaking. Growth is only one factor to examine, however. The more important question is whether such growth is profitable. Much of China’s growth is very real, and it generates the money necessary to keep the banks satisfied. But this growth really does not strengthen the economy. And if and when it slacks off, for example be­cause of a recession in the United States, the entire structure could crumble very fast.

This is not a new story in Asia. Japan was a growth engine in the 1980s. Conventional wisdom said it was going to bury the United States. But in re­ality, while Japan’s economy was growing fast, its growth rates were unsustainable. When growth slumped, Japan had a massive banking crisis from which it has not really fully recovered almost twenty years later. Similarly, when East Asia’s economy imploded in 1997, it came as a surprise to many, since the economies had been growing so fast.

China has expanded extraordinarily for the last thirty years. The idea that such growth rates can be sustained indefinitely or permanently violates basic principles of economics. At some point the business cycle, culling weak business, must rear its ugly head—and it will. At some point a simple lack of skilled labor will halt continued growth. There are structural limits to growth, and China is reaching them.

CHINA’S POLITICAL CRISIS

Japan solved its problem with a generation of low growth. It had the political and social discipline to do this without unrest. East Asia solved it in two ways. Some countries, like South Korea and Taiwan, imposed painful measures and came out stronger than ever, but this was possible only because they had strong states able to impose pain. Some countries, like Indonesia, never really recovered.

The problem for China is political. China is held together by money, not ideology. When there is an economic downturn and the money stops rolling in, not only will the banking system spasm, but the entire fabric of Chinese society will shudder. Loyalty in China is either bought or coerced. Without available money, only coercion remains. Business slowdowns can generally lead to instability because they lead to business failure and unemployment. In a country where poverty is endemic and unemployment wide­spread, the added pressure of an economic downturn will result in political instability.

Recall how China split into coastal and interior regions between the British intrusion and Mao’s triumph. Businesses on the coast, prosperous from foreign trade and investment, gravitated to their foreign interests, try­ing to break free from the central government. They drew in European imperialists—and Americans—who had financial interests in China. To­day’s situation is potentially the same. A businessman in Shanghai has interests in common with Los Angeles, New York, and London. In fact, he makes far more money from these relationships than he does from Beijing. As Beijing tries to clamp down on him, not only will he want to break free of its control, but he will try to draw in foreign powers to protect his and their interests. In the meantime, the much poorer people in the interior of the country will be either trying to move to the coastal cities or pressuring Beijing to tax the coast and give them money. Beijing, caught in the middle, either weakens and loses control or clamps down so hard that it moves back to a Maoist enclosure of the country. The critical question is which outcome is more likely.

The Chinese regime rests on two pillars. One is the vast bureaucracy that operates China. The second is the military-security complex that enforces the will of the state and the Communist Party. A third pillar, the ideological principles of the Communist Party, has now disappeared. Egalitarianism, selflessness, and service to the people are now archaic values, preached but not believed by or practiced by the Chinese people.

State, party, and security apparati are as affected by the decline in ideology as the rest of society. Communist Party officials have been the personal beneficiaries of the new order. If the regime were to try to bring the coastal regions under control, it is hard to imagine the apparatus being particularly aggressive, as it is part of the same system that enriched those regions. In the nineteenth century the same problem emerged when government officials along the coast didn’ t want to enforce Beijing’s edicts. They were on the side of doing business with foreigners.

If there is indeed a serious economic crisis, the central government will have to find a substitute ideology for communism. If people are to sacrifice, it must be for something they believe in—and if the Chinese cannot believe in communism, they can still believe in China. The Chinese government will attempt to limit disintegration by increasing nationalism and the natural companion of nationalism, xenophobia. Historically, China has a deep distrust of foreigners, and the party will need to blame someone for economic devastation. As Mao blamed foreigners for China’s weakness and poverty, the party will again blame foreigners for China’ s economic problems.

Since there will be substantial confrontations with foreign states on economic issues—they will be defending their economic investments in China—playing the nationalist card will come easily. The idea of China as a great power will substitute for the lost ideology of communism. Disputes will help bolster the position of the Chinese government. By blaming foreigners for problems and confronting foreign governments diplomatically and with growing military power, the Chinese will generate public support for the regime. This is most likely to take place in the 2010s.

The most natural confrontation would be with Japan and/or the United States, both historical enemies with whom smoldering disputes already exist. Russia is unlikely to be treated as an enemy. However, the probability of a military confrontation with the Japanese or the Americans is limited. It would be difficult for the Chinese to engage either country aggressively. The Chinese have a weak navy that could not survive a confrontation with the United States. Therefore, invading Taiwan might be tempting in theory but is not likely to happen. China does not have the naval power to force its way across the Taiwan Strait, and certainly not the ability to protect convoys shuttling supplies to Taiwanese battlefields. China is not going to develop a naval capacity that can challenge the United States within a decade. It takes a long time to build a navy.

China, then, has three possible future paths. In the first, it continues to grow at astronomical rates indefinitely. No country has ever done that, and China is not likely to be an exception. The extraordinary growth of the past thirty years has created huge imbalances and inefficiencies in China’s economy that will have to be corrected. At some point China will have to go through the kind of wrenching readjustment that the rest of Asia already has undergone.

A second possible path is the recentralization of China, where the conflicting interests that will emerge and compete following an economic slow­down are controlled by a strong central government that imposes order and restricts the regions’ room to maneuver. That scenario is more probable than the first, but the fact that the apparatus of the central government is filled with people whose own interests oppose centralization would make this difficult to pull off. The government can’ t necessarily rely on its own people to enforce the rules. Nationalism is the only tool they have to hold things together.

A third possibility is that under the stress of an economic downturn, China fragments along traditional regional lines, while the central govern­ment weakens and becomes less powerful. Traditionally, this is a more plausible scenario in China—and one that will benefit the wealthier classes as well as foreign investors. It will leave China in the position it was in prior to Mao, with regional competition and perhaps even conflict and a central gov­ernment struggling to maintain control. If we accept the fact that China’s economy will have to undergo a readjustment at some point, and that this will generate serious tension, as it would in any country, then this third out­come fits most closely with reality and with Chinese history.

A JAPANESE VARIANT

The advanced industrial world will be experiencing a contraction of population in the 2010s, and labor will be at a premium. For some countries, due to entrenched cultural values, immigration either is not an option or is at least a very difficult one. Japan, for example, is extremely averse to immigration, yet it must find a source of labor that is under its control and that can be taxed to support older workers. Most workers with a choice of where to go will not choose Japan, as it is fairly inhospitable to foreigners who want to become citizens. Koreans in Japan are not citizens of Japan. Even if they have lived all their lives and worked in Japan, they are issued papers by the Japanese police calling them “Korean” (neither north nor south) and are unable to become Japanese citizens.

Consider, however, that China is a vast pool of relatively low-cost labor. If the Chinese won’ t come to Japan, Japan may come to China, as it has be­fore. Using Chinese labor in enterprises created by the Japanese but located in China will be an alternative to immigration—and it will not only be Japan doing this.

Remember that Beijing will be trying simultaneously to tighten its grip on the country. Traditionally, when the central government is clamping down on China, it is prepared to accept lower economic growth. While a large- scale, concentrated Japanese presence sucking up Chinese labor might make a great deal of economic sense for local entrepreneurs and governments and even for Beijing, it makes little political sense. It would cut directly against Beijing’s political interests. But Japan will not want the Chinese gov­ernment diverting money to its own ends. That would defeat the entire purpose of the exercise.

By approximately 2020, Japan will have Chinese allies in the fight to bring in Japanese investment on terms favorable to Japan. Coastal regions will be competing to attract Japanese investment and resisting Beijing’s pressure and its nationalist ideology. Interior China might not benefit from Japan’s presence, but businesses and governments along the coast would. The Japanese, with large amounts of money, will have recruited allies in the coastal cities who do not want to pay the price that will be needed to satisfy the demands of the interior. An alliance between one or more coastal re­gions and Japan will emerge, confronting the power of Beijing. The amount of money that Japan will bring to bear will rapidly divide the central party itself and weaken the central government’s ability to assert its con­trol on the coastal cities.

China will be seen as part of the solution for countries like Japan that are feeling heavy pressure from demographic problems but cannot manage large-scale immigration. Unfortunately the timing will not be good. An in­evitable downturn in the Chinese economy will make the central govern­ment more assertive and more nationalist. But the central government will itself be weakened by the corrosive effect of money. China will remain for­mally united, but power will tend to devolve to the regions.

A very real future for China in 2020 is its old nightmare—a country divided among competing regional leaders, foreign powers taking advantage of the situation to create regions where they can define economic rules to their advantage, and a central government trying to hold it all together but failing. A second possibility is a neo-Maoist China, centralized at the cost of economic progress. As always, the least likely scenario is the continuation of the current situation indefinitely.

It all boils down to this: China does not represent a geopolitical fault line in the next twenty years. Its geography makes that unlikely under any cir­cumstances, and China’s level of military development needs more than a decade to overcome this geographical limit. Internal stresses on the Chinese economy and society will give China far greater internal problems than it can reasonably handle, and therefore it will have little time for foreign pol­icy adventures. To the extent that China will be involved with foreign pow­ers, it will be defending itself against encroachment rather than projecting its own power.