The Rise of China and Its Effect on Taiwan, Japan, and South Korea: U.S. Policy Choices

CRS Report for Congress
The Rise of China and Its Effect on Taiwan, Japan,
and South Korea: U.S. Policy Choices
Updated January 13, 2006
Dick K. Nanto
Specialist in Industry and Trade
Foreign Affairs, Defense, and Trade Division
Emma Chanlett-Avery
Analyst in Asian Political Economy
Foreign Affairs, Defense, and Trade Division

Congressional Research Service ˜ The Library of Congress

The Rise of China and Its Effects on Taiwan, Japan,
and South Korea: U.S. Policy Choices
The economic rise of China and the growing network of trade and investment
relations in northeast Asia are causing major changes in human, economic, political,
and military interaction among countries in the region. This is affecting U.S. relations
with China, China’s relations with its neighbors, the calculus for war across the
Taiwan Straits, and the basic interests and policies of China, Japan, Taiwan, and
South Korea. These, in turn, affect U.S. strategy in Asia. China, for example, has
embarked on a “smile strategy” in which it is attempting to coopt the interests of
neighboring countries through trade and investment while putting forth a less
threatening military face (to everyone but Taiwan). Under the rubric of the Six-Party
Talks, the United States, China, Japan, Russia, and South Korea are cooperating to
resolve the North Korean nuclear crisis. Taiwanese businesses have invested an
estimated $70 to $100 billion in factories in coastal China. China relies on foreign
invested enterprises for about half its imports and exports. For Taiwan, Japan, and
South Korea, China has displaced the United States as their major trading partner.
China interacts with Taiwan, Japan, and South Korea on four levels: human
relations, economic and financial interaction, diplomatic and political intercourse,
and military relations. The temperature of relations at each level ranges from cold
to hot depending on the type of interaction and country or state being considered. At
the human level the temperatures are mixed, at the economic level hot, at the
diplomatic level cold for Taiwan to warm for South Korea, and at the military level,
temperatures of interaction are cold.
The implications of China’s globalization and rise as a major economic power
can be seen in its impact both on Beijing and on policy deliberations in Taipei,
Tokyo, and Seoul. The Chinese Communist leadership not only is having to cede
space in its decision making process to industrial interests but the leaders themselves
are coming into power with experience in the transformation of society that comes
from development and modernization after opening to the outside world. China now
depends on international investment and trade for the economic growth needed to
maintain the party’s legitimacy. For China’s trading partners, dependency on the
Chinese market means that Beijing is looming larger in all aspects of policy making.
While this is not likely to challenge U.S. security ties with Japan, South Korea, and
Taiwan, it raises several policy issues. One is how to deal with a modernizing and
more powerful Chinese military financed by the growing Chinese economy. Another
is how to explicitly incorporate into U.S. policy the greater weight that Beijing is
being given in policy deliberations in Tokyo and Seoul. A further policy issue is
whether to take explicit measures to offset the rising economic clout of China and
attempts by Beijing to create East Asian institutions with China at the center and the
United States pushed to the periphery. A positive result of the mutual trade and
financial dependency that has developed in northeast Asia is that all parties now have
much to lose by an international military crisis that would interrupt economic and
financial flows in the region. All four governments, therefore, seek stability in
international relations. This report will be updated as circumstances warrant.

China’s Evolving Strategy...........................................3
Globalization and the Rise of China...................................3
Bilateral Relationships in Northeast Asia..............................11
Beijing-Taipei ...............................................11
Beijing-Tokyo ...............................................18
Beijing-Seoul ................................................24
Policy Discussion.................................................28
Policy Choices for Congress........................................32
Status Quo..............................................32
Containing China.........................................33
Counterbalancing the Rising Economic Influence of China........34
Bringing China’s External Trade More into Balance.............35
Facilitate Globalization/Democracy..........................36
Third Country Policies.....................................37
List of Figures
Figure 1. Exports by South Korea, Japan, and Taiwan to China
and the United States, 1995 and 2004 ($billion)......................4
Figure 2. PRC and U.S. Exports to South Korea, Japan, and Taiwan
1995 and 2004 ($billion)........................................5
Figure 3. Foreign Direct Investment Inflows into the United States,
China, Japan, South Korea, and Taiwan, 1995, 2000-03................6
Figure 4. Percent of China’s Exports and Imports Accounted for by Foreign
Funded Enterprises in China, 1988-2003............................8
Figure 5. Global High Technology Market Shares
1980-2001 ...................................................9
Figure 6. Temperature, Strata of Interaction, and Influence in Relations
Between the People’s Republic of China and Taiwan.................12
Figure 7. Temperature, Strata of Interaction, and Influence in Relations
Between the People’s Republic of China and Japan..................19
Figure 8. Temperature, Strata of Interaction, and Influence in
Relations Between the People’s Republic of China and South Korea.....25

The Rise of China and Its Effects on
Taiwan, Japan, and South Korea: U.S.
Policy Choices
The economic rise of China and the growing network of trade and investment
relations in northeast Asia are causing major changes in human, economic, political,
and military interaction among countries in the region. This is affecting U.S. relations
with China, China’s relations with its neighbors, the calculus for war across the
Taiwan Straits, and the basic interests and policies of China, Japan, Taiwan, and1
South Korea. These, in turn, affect U.S. strategy in Asia.
All nations pursue their fundamental interests of security and prosperity within
a context of military, political, diplomatic, and economic forces combined with an
underpinning of momentum, history, national ethos, and existing relationships.
Added to this are the personalities of national leaders and their respective abilities to
move their countries in particular directions. Over time, within this ever-changing
intersection of forces, friendly nations may turn hostile, or enemies may turn into
friends. As the old saying goes, nations have no permanent friends and no permanent
enemies, only interests — and these interests can be achieved in a myriad of ways.
For the United States, most frequently, instead of discrete discontinuities in
relationships, there occurs a steady erosion or accretion in the degree to which these
nations support or oppose U.S. policies interspersed by occasional tipping points in
which relationships take dramatic turns in one way or another.
Indicators of the shifting ground and complex intersection of interests in
northeast Asia are several. The People’s Republic of China (PRC) has embarked on
a “smile strategy” in which it is attempting to coopt the interests of neighboring
countries through trade and investment while putting forth a less threatening military
posture (except for Taiwan, toward which it has adopted a dual approach). Under the
rubric of the Six-Party Talks, the United States, China, Japan, Russia, and South
Korea are cooperating to resolve the North Korean nuclear crisis. China is using its
low-cost production base to integrate Taiwan’s economy into the PRC. Taiwanese
businesses have invested an estimated $60 to $100 billion in factories in coastal
China. South Korea is exporting more to China than to the United States, while
Japan buys more from China than from the United States. Demand from China has
played a key role in Japan’s economic recovery. Elsewhere in northeast Asia, North
and South Korea are cooperating in building the Kaesong special economic zone notth
far from the heavily fortified 38 parallel (demilitarized zone). Tokyo and Seoul are

1 The Kearny Alliance Foundation provided research support, and individuals, government
organizations, and think tanks in Japan, China, and Taiwan provided information and
analysis for this report.

both seeking some rapproachment with Pyongyang and a free trade agreement
between their two nations.
The purpose of this report is to examine the rise of China and forces of
globalization (the internationalization of markets, politics and legal systems) in an
emerging new order in northeast Asia. China is rapidly becoming the economic
heavyweight in Asia, and this is having a major effect on the PRC’s relationships
with Japan, Taiwan, and South Korea. The focus of this report is on the use of “soft
power” (as contrasted with “hard” military power) in inducing China, Taiwan, Japan,
and South Korea to pursue certain policy paths and how that affects U.S. policy and
goals. This report examines trade and investment flows along with increased
communication and travel to see how they are altering the basic cost-benefit
calculations related to the security of these nations and how Taiwan, Japan, and
South Korea are responding to the rise of China. A focus of this report is whether
globalization is working to induce northeast Asia nations to behave in ways that
promote peace and stability in the region and to ease tensions.
An argument could be made, for example, that for Beijing the potential costs in
decreased trade, lower investment inflows, and lost jobs that would occur should it
invade Taiwan are rising with each new Taiwanese factory opened. In this case, the
economic forces can be seen as stabilizing. The military establishment in both
Taiwan and Japan, however, are viewing the growing strength of the Chinese
economy and the concomitant military buildup that it has enabled with some alarm.
In that sense, globalization and the armaments it has financed has been destabilizing
— both Taiwan and Japan have had to adjust their military capabilities to cope with
a growing potential Chinese threat. In a larger sense, the lure of the Chinese market
for Japanese, Taiwanese, and South Korean exporters tends to provide a stabilizing
force as all would lose by a large disruption in trade flows.
For Congress, one question is how to promote and protect U.S. interests while
northeast Asia undergoes rapid economic change and the imperatives of the
containment of communism fade. The policy choices for northeast Asia include
whether to:
!continue current policies of promoting market economies, enabling
globalization, and encouraging democracy while projecting
sufficient military power to keep the peace in the region;
!seek to contain China along the same lines of the containment of the
former Soviet Union;
!actively counterbalance the rising economic influence of China and
the trading networks it is building by pursuing free trade agreements
and closer investment relations with Japan, South Korea, and
Taiwan and by strengthening free trade process under the Asia
Pacific Economic Cooperation (APEC) forum;
!bring China’s external trade more into balance, ensure that China
adheres to its World Trade Organization commitments, reduce the
foreign exchange resources available to China’s central government,

and slow the “bandwagon effect” by which Japanese, South Korean,
and Taiwanese businesses are establishing factories in China with
the intention of selling a part of the output in the U.S. market;
!facilitate the globalization of China in order to strengthen forces of
change, create centers of power outside of Beijing, and increase
representation in Beijing by business and international interests; and
!take into greater account the impact that the rise of China is having
on the policies of Japan, South Korea, and Taiwan.
China’s Evolving Strategy
Even before the 9/11 terrorist attacks on the United States, the People’s
Republic of China was shifting its strategy with respect to its neighboring countries
and Washington away from confrontation and strategic competition toward economic
cooperation and a reduction of strategic aggressiveness. Following several crisis
points in China’s international relations — including the 1989 Tiananmen Square
repression, the 1995 seizure by China of Mischief Reef in the Spratly Islands, the
1995-96 live fire missile exercises in the Taiwan Strait, the 1997-98 allegations of
Chinese espionage, the 1999 NATO bombing of the Chinese embassy in Belgrade,
and the 2001 U.S. EP-3/Chinese fighter aircraft collision incident — Chinese
relations with its northeast Asian neighbors and with the United States have now
become fairly calm and constructive.
Why China has turned its focus toward its own “peaceful development” rather
than blatantly asserting what it considers to be its territorial rights and periodically
“poking fingers in the eyes of its neighbors” is a complex question that will be
addressed partly below. It seems clear, however, that Beijing has recognized that its
attempts to assert sovereignty over disputed islands or the test firing of missiles near
Taiwan have proven to be counterproductive. Recent conflicts in Iraq and
Afghanistan, moreover, have demonstrated anew that the United States is the premier
global power and that the U.S. military holds a large technological lead in the
conduct of war. Beijing sees a huge cost to an open conflict with the United States.
In the post 9/11 environment, moreover, Beijing has been able to position itself in a
way that puts it on the side of Washington in the global antiterrorism campaign —
despite Beijing’s concerns over the growing American military presence near the
western border of China in Central Asia. Beijing’s leaders also recognize that the
legitimacy of their monopoly on government rests primarily on their ability to deliver
a rising standard of living to their people. This not only requires continued economic
growth but stability in the region and undisturbed flows of capital and goods between
China and the rest of the world.
Globalization and the Rise of China
The economic rise of China has generated a reorientation of international trade
patterns in Northeast Asia. For Japan, South Korea, and Taiwan, China has

surpassed the United States as their number one trading partner. As shown in Figure
1, in 1995, South Korea exported more than twice as much to the United States as it
did to China ($24 billion vs. $10 billion). By 2004, South Korea was exporting $50
billion to China but $46 billion to the United States.2 Japan still exports more to the
United States than to China, but the trend is moving toward China. In 1995, Japan
exported over three times more to the United States than to China ($123 billion vs
$29 billion), but by 2004, exports to the American market had risen to $130 billion
while those to China had risen to $74 billion. With Taiwan, the story is similar. In
1995, Taiwan3 exported twice as much to the U.S. market as it did to the PRC ($29
billion vs $15 billion). By 2004, Taiwan was exporting $35 billion to the United
States and $34 billion to China. (Unlike Japan when it was industrializing, China is
a major importer.)
Figure 1. Exports by South Korea, Japan, and Taiwan to China
and the United States, 1995 and 2004 ($billion)
S. Korea
$50 (2004)$46 (2004)
$10 (1995)$24 (1995)
$74 (2004)$130 (2004)
China $29 (1995)U.S.$123 (1995)
$34 (2004)$35 (2004)
$15 (1995)$29 (1995)
Data Sources: World Trade Atlas, S. Korea, Taiwan.1995
The situation with respect to China’s exports to South Korea, Japan, and Taiwan
is similar. As shown in Figure 2, China’s exports to Japan more than tripled
between 1995 and 2004 and at $94 billion now exceed the $54 billion in U.S. exports
to Japan. The United States still exports more to Taiwan ($22 billion) than does the
PRC, but China’s exports there have quintupled to $17 billion in 2004 from $3
billion in 1995. Likewise, China’s exports to South Korea have quadrupled since

2 For more information, see CRS Report RL30566, South Korea-U.S. Economic Relations:
Cooperation, Friction, and Future Prospects, by Mark E. Manyin.
3 Separate Customs Territory of Taiwan, Penghu, Kinmen and Matsu also called Chinese

1995 and at $29 billion exceed those from the United States ($26 billion) — barely
up from the $25 billion in 1995. The pattern of exports from China and the United
States to South Korea, Japan, and Taiwan replicate the import trends — China is
rising while the United States is static as a source of supply for these markets.
Figure 2. PRC and U.S. Exports to South Korea, Japan, and

1995 and 2004 ($billion)

S. Korea
$29 (2004)$26 (2004)
$7 (1995)$25(1995)
$94 (2004)$54 (2004)
China $28 (1995)U.S.$64 (1995)
$17 (2004)$22 (2004)
$3(1995)$19 (1995)
Data Sources: World Trade Atlas for Japan. S. Korea & Taiwan trade ministries.1995
These shifts in trade flows away from the United States indicate that dependency
relationships also are turning toward China. Not only are Japan, Taiwan, and South
Korea becoming more dependent on China, but China also is becoming more
dependent on these economies for imports and exports. Many of the imports into
China, moreover, are intermediate products and capital goods that are vital to China’s
industrial sector and economic growth and enable China to export to the U.S. and
other markets. Exports to China, moreover, are important sources of aggregate
demand for countries such as Japan — a nation that has been in and out of recession
since 1992.
Another indicator of the shifting positions of the United States and China can
be seen in foreign direct investment — FDI or long-term investment in controlling
shares of companies. This is investment in companies that provide goods and
services in which the foreign investor controls 10% or more of the shares. Looking
first at the aggregate flows from all sources, Figure 3 indicates that while the United
States is still the preferred destination for foreign direct investment, the trend is
turning toward China. In 2003, China received $54 billion in FDI while the United
States received $30 billion. Both the United States and China swamp Japan, South

Korea, and Taiwan as destinations for FDI. The United States, however, is also a
major provider of FDI. In 2003, Americans invested $152 billion abroad while China
invested $2 billion in FDI. In addition, since the United States has long been a
favored destination for foreign investors, its cumulative stock of inward FDI as of

2003 was three times that of China ($1,554 billion vs $501 billion).

These aggregate FDI inflows into China play a geopolitical role in that they raise
the cost of instability both within the PRC and between the PRC and its neighbors,
particularly Taiwan. More important than the total inflows from the world, however,
are the flows to China from its neighboring economies. Of the $53.5 billion realized
foreign direct investment in 2003, $5.1 billion came from Japan, $4.5 billion from
South Korea, and $3.4 billion from Taiwan. China’s largest investor, however, was
Hong Kong with $17.7 billion (some of this was actually Chinese money which
“round tripped” in order to take advantage of incentives that favor foreign
investments). The U.S. total of $4.2 billion was slightly less than South Korea’s $4.5
billion but more than Taiwan’s $3.4 billion. The general trend of foreign direct
investment within northeast Asia has been for it to increase or remain at a fairly
substantial level. The United States is maintaining its rate of direct investment in
China, but that level is just on a par with that of South Korea.
Figure 3. Foreign Direct Investment Inflows into the United States,
China, Japan, South Korea, and Taiwan, 1995, 2000-03
59 4763 53 54
38 413050
0 1 23 9 56 449 3 16 4 10
1995 00 01 022003 199500 01 022003
United StatesJapanTaiwan
ChinaSouth Korea
Data Source: UNCTAD, Foreign Direct Investment Database
For Japan, China accounted for $3.1 billion or 8.6% of its total $36.1 billion in
direct foreign investment in 2003. Japan still invests more than three times as much
in the U.S. market ($10.6 billion in 2003) as it does in China, but the trend is striking.

Between 1999 and 2003, Japan’s foreign direct investment in the United States
dropped by 52%, while its FDI in China rose by 314%.4
Other types of foreign investment are less significant in China than in countries
with more developed capital markets. In 2003, foreigners put a total of $2.64 billion
in non-FDI investments in China (data are not available by country). This included
$0.27 million in non-controlling shares, $0.13 million in leasing, $0.01 million in
compensation trade, and $2.23 million in processing and assembly.5
In bank borrowing, as of June 2005, China had a total of $98.6 billion (up from
$78.5 billion in June 2004) loans outstanding from various sources. Of these,
Japanese banks accounted for $17.4 billion — the largest source except for European
banks who had $45.2 billion in claims on China. U.S. banks had $11.2 billion in
loans to China (up from $6.9 billion in June 2005). Other large northeast Asian
borrowers from Japan include South Korea with $17.0 billion and Taiwan with $5.7
billion. 6
In northeast Asia, therefore, a network of economic interdependence is
developing in which China, Japan, South Korea, and Taiwan have strong vested
interests in the smooth and continuous operation of the system. Economic
integration there is not as extensive as that in the European Union or under the North
American Free Trade Area (NAFTA), but it is developing rapidly. Not only are these
economies trading more extensively with each other, but their production processes
are becoming vertically integrated. China acts as the manufacturing platform while
neighboring countries provide investment capital, finance, technology, management
skills, and expertise.

4 Japan. Ministry of Finance. Outward Direct Investment. Percentages based on yen figures
(for the U.S.: ¥2,500.2 billion in 1999 to ¥1,195.5 billion in 2003; for China ¥85.8 billion
in 1995 to ¥355.3 billion in 2003). []
5 China Data Online. Yearly Macro-economy Statistics. Actually Used Foreign Investment.
[ eng/ default.asp]
6 Bank for International Settlements. Consolidated Banking Statistics for Second Quarter
of 2004. October 2004.

Figure 4. Percent of China’s Exports and Imports
Accounted for by Foreign Funded Enterprises in China,
30 E xport sIm ports
1988 89 90 91 92 93 94 95 96 97 98 99 2000 1 2 3
Source: Data from China Statistical Yearbook and China Customs Statistics.
Perhaps more important than the amounts of trade flows and foreign direct
investment and loans flowing into China are the economic ramifications of that
investment. Currently, more than half of China’s exports and imports originate from
foreign affiliated enterprises located in its economy. In 2003, as shown in Figure 4
above, 55% of China’s exports and 56% of its imports were accounted for by foreign
funded enterprises. Among provinces and metropolitan areas, Guangdong, Jiangsu,
Shanghai, and Fujian were particularly significant. All these are coastal areas with
a large foreign presence.
China’s level of technology also has benefitted greatly from foreign investment
and imports of machinery and equipment. Although recent data are not available,
China’s global market share of high-technology products (aerospace, pharma-
ceuticals, computers and office machinery, communication equipment, and scientific
instruments) has risen from less than 1% in 1980 to 8.7% in 2001 (see Figure 5).
This was considerably less than the 32% for the United States, but exceeded that of
Germany or South Korea.7

7 National Science Board, Science and Engineering Indicators, 2004. Figure O-31.

Figure 5. Global High Technology Market Shares


United States
European Union
10 Germ any Ch in a
South Korea
1980 85 89 90 91 92 93 94 95 96 97 98 99 2000 1
Source: National Science Board, Science and Engineering Indicators, 2004.
Meanwhile, China is using the allure of its rapidly developing economy and
trade relations to create a regional economic sphere revolving around China and with
industries vertically integrated across countries. The major first thrust has been with
the Association of South East Asian Nations8 (ASEAN). China and ASEAN agreed
in 2002 to negotiate an ASEAN-China free trade agreement (ASEAN + 1) to be
implemented between China and the six industrialized ASEAN countries by 2010
and the rest by 2015. ASEAN also is considering the possibility of expanding this
to an East Asia Free Trade Area (EAFTA or ASEAN + 3) that also would include
Japan and South Korea.9 Japan and South Korea also are discussing a free trade
agreement between them,10 and Taiwan has sought closer ties with Japan and South
Korea. Taiwan is clearly concerned over what it calls the bandwagon effect —
countries in the region “jumping on the bandwagon” to cement trade ties with China.
East Asian countries also are joining forces to protect their currencies and avoid
a repeat of the 1997-99 Asian financial crisis. In May 2000, finance ministers from
ASEAN plus China, Japan, and South Korea established the first regional financing
arrangement in East Asia. Called the Chiang Mai Initiative, this consists of bilateral
currency swap arrangements — mainly from Japan, China, and South Korea to other
8 Established on August 8, 1967, ASEAN members include Indonesia, Malaysia,
Philippines, Singapore, and Thailand (the five original members), as well as Brunei
Darussalam (joined in 1984), Vietnam (1995), Laos and Burma/Myanmar (1997), and
Cambodia (1999).
9 Association of Southeast Asian Nations. Chairman’s Statement of the 8th ASEAN + 3
Summit, Vientiane, November 29, 2004.
10 Japan has an Economic Partnership Agreement (a limited FTA) with Singapore and
Mexico and is negotiating EPAs with the Philippines, Thailand, and Malaysia.

participating nations — during financial crises.11 Another regional financial
arrangement is the Asia Bond Fund. Announced on June 2, 2003, the fund began
with $1 billion in contributions from 11 central banks from the more developed
countries of ASEAN plus Japan, China, South Korea, and Australia. Seven
additional contributing countries (including India) have joined the fund. The fund
is to invest in sovereign and quasi-sovereign bonds issued by Asian governments in
international markets. Initially restricted to investments by central banks, in the
second phase, the fund is to be opened to private investors (such as insurance
companies and pension funds). The intention is to create greater liquidity, less
reliance on dollar-denominated financial assets, deeper regional capital markets, and
more stability in the Asian financial markets.12 These financial arrangements are
evidence of nascent cooperation and institution building among East Asian nations
— with both Japan and China playing major roles.
Within China, moreover, economic success is affecting decision making and
policies in the ranks of the Chinese Communist Party (CCP). The CCP is including
more of China’s business and other interests both in its membership and policies. An
estimated 30% of China’s entrepreneurs (several million) are now members of the
CCP.13 These entrepreneurs are not poor peasants; many are the business elite. In
addition, numerous party members have, themselves, become involved in businesses
or have strong business interests. China may still be a one-party state, but that one
party is gradually recognizing that it must reflect the interests of the people —
including those with business and economic interests — if it intends to remain in
power. 14
A further effect of the rapid development of China’s economy is its growing
appetite for raw materials and energy and other accouterments of modern life. In the
market for petroleum, for example, China’s demand already has reached 6.7 million
barrels per day, and in 2020 is expected to climb to 12.0 million barrels per day or
about 11 percent of world consumption.15 Similar increases are occurring in Chinese
demand for steel, gold, natural gas, and other commodities. This is pushing up world
prices for these items.
One note of caution is that several negative factors are rising in China that could
push the country into economic chaos or recession. While economic projections by
econometric forecasting firms (such as Global Insight) foresee continued economic

11 Asian Development Bank. Progress and Institutional Arrangements for the Chiang Mai
Initiative. October 6, 2003.
12 Hong Kong Monetary Authority. The Asian Bond Fund. TDC Trade, Economic Forum
[ h t t p : / / www.t d ct r a e conf or um/ h kma/ hkma m] .
13 Kennedy, Scott. Divining China’s Future. World Policy Journal, Vol. XXI, Winter

2004/05, p. 83.

14 The Three Represents — CPC’s New Thinking. China Daily (Internet edition), December
2, 2003. Li, Cheng. China’s Northeast: From Largest Rust Belt to Fourth Economic
Engine? China Leadership Monitor, Winter 2004, No.9.
15 Global Insight, Inc. Global Petroleum Outlook, Winter 2004-05.

growth in China at around 7 or 8% for the medium term,16 China could encounter a
political or security crisis (e.g., over Taiwan independence), a banking crisis, internal
unrest, or just a hard landing from its rapid rates of economic expansion that could
derail the optimistic projections that are the conventional wisdom of most China
Bilateral Relationships in Northeast Asia
In no area is the mix of economics and security more intertwined than across the
Taiwan Strait. China’s strategy has been to maintain a truculent position against
Taiwan independence with credible threats of military action against what Beijing
considers to be a “renegade province” should Taiwan attempt to make its de facto
quasi-independent status into one more de jure. China has backed up its rhetoric by
deploying an estimated 600 missiles that can be aimed at Taiwan along the south
China coast and augmenting its ability to launch naval attacks. On the other hand,
the PRC has encouraged Taiwan businesses to invest in the PRC in the hope that the
increasing economic and financial interdependence would ameliorate the political
forces for independence. In a white paper, Beijing said that with respect to Taiwan,
“doors have been flung open to facilitate the flow of goods and people. Businessmen
from Taiwan are welcome to invest or trade on the mainland. They are accorded
preferential treatment and legal safeguards.”17
By creating a dependency by Taiwan’s businesses on Chinese workers,
subsidiaries, sources of supply, and markets, China has sought to win the “hearts and
minds” of Taiwanese business interests. In the process, however, China also has
created its own dependency on Taiwanese businesses — particularly in information
technology industries — for advanced technology, manufacturing methods, and
export channels.
Cross-Strait relations occur at various levels. As shown in Figure 6, the strata
of interaction between the PRC and Taiwan begin at the human or individual level
and increase in the degree of institutionalization through economic interaction,
diplomatic/political, and finally military. All cross-strait interaction takes place in
a context of clashing attitudes that includes a rising sense of a separate national
identity in Taiwan and a strong sense of territorial integrity and sovereignty in the

16 Global Insight. China — Summary of Detailed forecast.
17 Peoples Republic of China. The Taiwan Question and Reunification of China, White
Paper On Taiwan Issue, April 16, 2001. On Internet at
[ web/webportal/W2037416/A2054766.html ]

Figure 6. Temperature, Strata of Interaction, and Influence in
Relations Between the People’s Republic of China and Taiwan
PRC's Influence With TaiwanTaiwan's Influence with the PRC
US Arms Sales, Intervention
Military (Cold)
Threaten Taiwan, Deploy Arms
Independence Movement
Diplomatic/Political (Cold)
Isolate, Diplomatic Pressures
Trade Investments
Economic (Hot)
Trade Investments
National Identity Communications
Human/Individual (Mixed)
Communications Nationalism
Congressional Research Service
Human and individual interaction tends to be the least institutionalized and
entails little government action (except to allow it). It includes direct human
interaction, communication, development of attitudes (particularly nationalism and
national identity), media, Internet, and family ties. Some indicators of the extent of
human interaction across the Taiwan Strait are that in recent years around 13 million
Taiwanese have visited the PRC and more than 250,000 people from the PRC have
visited Taiwan.18 In January 2003, the first charter flights flew between Shanghai and
Taipei via Hong Kong to take Taiwanese business people home for the New Year
holidays.19 Flights were renewed for the spring festival in 2005. The interaction also
includes more than 210,000 marriages — mainly between Taiwanese businessmen
and Chinese women — with 90,000 PRC spouses now living in Taiwan.20 This
coincides with a multitude of other person-to-person contacts, reunions of relatives,
communication, and entertainment.
At this level, the temperature of interaction is mixed. For communications,
travel, and family ties, it is warm, while in terms of nationalism, the movement in

18 CRS Issue Brief IB98034, Taiwan: Recent Developments and U.S. Policy Choices, by
Kerry B. Dumbaugh.
19 Lin, Miao-Jung. First Charter Flight to Land This Morning. Taipei Times, January 26,

2003, p. 1.

20 Taiwan. Mainland Affairs Council. Press Release No. 55, August 20, 2004.

Taiwan toward a national identity separate from that of China and in attitudes toward
each other, the temperature is cool. Human and individual interaction affects
government policy on each side only as it is transmitted upward and institutionalized.
Conventional wisdom holds that the more democratic and representative a
government, the more influence such interaction is likely to have on national policy.
Popular pressures on Taipei, therefore, may be relatively stronger than those on
Beijing. But even decision makers in Beijing and elsewhere in China are
experiencing increasing constraint from public sentiments. Also for Beijing, the
widespread and strong attitudes toward territorial integrity and sovereignty place
further constraints on the shape any resolution the Taiwan problem can take.
Human interaction often occurs within the context of the next higher stratum:
economic and financial interaction. Economic and financial interests drive
engagement at this level. The temperature of this type of interaction is very warm —
even hot — with contacts extensive and growing. While governments determine the
extent to which their economies are open to foreign trade and investments, businesses
and individuals usually conduct actual transactions independently of government
action. In economics and trade, both Taiwan and the PRC hold strong leverage over
the other. The two economies complement each other and depend on each other for
financing, technology, labor, and manufacturing expertise. Taiwanese businesses
have invested between $70 billion and $100 billion in the PRC — about half of all
Taiwanese overseas investment. About a million Taiwanese businessmen and their
families reside in China — some 400,000 in the Shanghai area alone. China has not
been as free to invest in Taiwan, but even that is gradually opening up. As the host
of Taiwanese investment and because of the mutual dependency that has developed,
Beijing holds Taiwanese businesses in a situation somewhat akin to a “hostage.” In
case of hostilities, Taiwanese businesses cannot just pull up stakes and go home.
Taiwan, however, also has leverage over Beijing. Without Taiwanese expertise,
China would have a difficult time developing certain of its high technology
This mutual dependency is readily apparent in the information technology (IT)
sector. Taiwanese companies have invested heavily in manufacturing facilities in the
Pearl River Delta adjoining Hong Kong and, more recently, in Shanghai. In 2003,
60% of Taiwan’s IT hardware was made in the PRC. Taiwanese-invested companies
in the PRC produced more than 70% of the electronics made there.21 The United
States, China, and Taiwan increasingly are becoming an integrated market for
semiconductor manufacturing and consumption. Both the United States and Taiwan
keep their highest levels of technology at home, but China has become a major
manufacturing platform for quite sophisticated computer chips. In semiconductor
wafer foundries, for example, as of December 2004, eight of the nine major Chinese
companies were able to manufacture 8-inch wafers. Two were making the latest
generation of 12-inch wafers. Their sources of technology were Taiwanese (Taiwan
Semiconductor Manufacturing Co., United Microelectronics), European (Philips,

21 Chase, Michael S., Kevin L. Pollpeter, and James C. Mulvenon. Shanghaied? The
Economic and Political Implications of the Flow of Information Technology and Investment
Across the Taiwan Strait. Rand Technical Report, July 2004. P. xiii, xvii.

Alcatel), and Japanese (Oki, Sanyo, NEC, Fujitsu).22 Taiwan also has allowed its
companies to transfer production of notebook computers to China. China and
Taiwan together dominate production of motherboards (72% global market share),
graphic cards (77%), PC notebook computers (62%), flat panel monitors (67%), and
are major producers of optical disk drives (41%), cellular phones (33%), ink-jet
printers (53%), and PC desktop computers (23% of the global market) with most of
each share being produced in China.23
For years, both sides restricted interaction, particularly any that involved the
transfer of high-level technology. As China has liberalized its trade and capital
markets, however, strong business pressures have developed in Taipei to do the
same. For example, in 2002, after extensive lobbying by major Taiwanese
semiconductor companies, the government in Taipei relaxed its ban on investments
in semiconductor facilities in the PRC. Business also have asked Taipei to permit
Chinese nationals to work for high-technology companies in Taiwan (which had been
prohibited).24 In January 2001, the two sides established the “three mini-links” which
permitted direct transportation, commerce, and postal exchanges between two
Taiwan-controlled islands and their coastal Chinese neighbors. In October 2001,
Taipei announced new visa procedures that make entry and working in Taiwan easier
for PRC professionals. Other events in cross-strait relations have included the
decision by oil companies in the PRC and Taiwan to explore jointly offshore areas
for oil and Taiwan’s opening to third-country and selected PRC and Taiwanese ships
to carry cargo to and from designated ports in Taiwan and in the PRC25 In 2001,
Taipei replaced its “be patient” policy for dealing with two-way flows with China
with one of “active opening with effective management.”
As shown in Figures 1 and 2, trade between the PRC and Taiwan has been
growing rapidly. China is now Taiwan’s largest export market, and Taiwan runs a
trade surplus with the PRC of about $25 billion. Because of goods flowing through
Hong Kong, each side reports different numbers, but both indicate a rapidly rising
trend. Both imports and exports have increased dramatically. Taiwan’s imports from
the PRC have risen from $3 billion in 1995 to $16.7 billion in 2004. Over the same
period, China reported that imports from Taiwan rose from $15 billion to $64.7
billion, while Taiwan reported a comparable rise of exports to China of $0.4 billion
in 1995 to $34.0 billion in 2004. Since joining the World Trade Organization,

22 Nomura Securities, IEK/ITRI (November, 2004) cited by Eric Chen, Sunplus, Design
Session, From a Fabless Perspective, Taiwan/China Semiconductor Industry Outlook, 2004.
December 7, 2004, San Jose, California.
23 Dataquest as cited by Walden Rhines in “Driving Semiconductor Industry Optimization
from U.S.-Taiwan-China Relationships. Paper presented at the Taiwan/China
Semiconductor Industry Outlook, 2004, December 7, 2004, San Jose, California.
24 Ibid.
25 CRS Issue Brief IB98034. Taiwan: Recent Developments and U.S. Policy Choices, by
Kerry Dumbaugh.

Taiwan increased the items allowed to be imported from China from about 2,000 to
over 8,500 (78% of total items produced) in 2004.26
The extent of Taiwan’s rising integration and dependency on the PRC economy
has been a cause of great concern in Taipei. The government there has attempted to
diversify investments away from China with a “go-south” policy (invest in and trade
with Southeast Asia instead of China), but the allure of the PRC with its low-cost
labor, common language, and economic incentives continues to draw in businesses.
Taipei cautions its businesses about the risks of investing in the PRC, but only
intervenes to keep the latest technology from migrating there.27
At the diplomatic and political level, cross-strait relations have been cold
(frigid). Beijing is using its rising economic and political clout as leverage in
furthering its diplomatic agenda. China has held the upper hand in barring Taiwan
from membership in most major international organizations (Taiwan’s accession to
the World Trade Organization was as a separate customs territory) and from
receiving diplomatic recognition from the major countries of the world. The PRC
has been particularly aggressive and uncompromising, even going so far as blocking
Taiwan from receiving unofficial observer status in the World Health Organization
and preventing the president of Taiwan from attending the annual meetings of the
leaders of the 21 member states at the Asia Pacific Economic Cooperation forum.
China’s diplomats also are taking the lead in regional meetings, and China’s
economic clout is inducing countries that previously recognized Taiwan to shift their
diplomacy toward Beijing.28 Taiwan, on the other hand, has also been pressing for
more room to maneuver on both the diplomatic and political levels. President Chen
Shui-ban has emphasized that Taiwan is a sovereign state and should not be
downgraded, marginalized, or treated as a local government.29
Overhanging the diplomatic and political level of interaction is the constant
threat of military action as a deterrent, coercive force, and other means to forcibly
accomplish what peaceful methods may not achieve. Partly in response to what
Beijing views as Taiwan’s inching toward independence, in March 2005, China
enacted an Anti-secession Law codifying the use of force against Taiwan should it
move toward formal independence.30 At the military level, therefore, cross-strait
relations are cold. The Pentagon reports that after close to 20 years of spectacular
economic growth in China, Beijing’s diplomatic successes, and steady improvement

26 Interview at the Mainland Affairs Council, Taipei, January 30, 2005.
27 Taiwan’s Ministry of Economic Affairs reviews investments in China valued at greater
than $20 million. If less than $20 million, there is simplified screening only. Taiwan
prohibits investments in China for infrastructure construction and high technology.
28 Norton, Michael. China Wooing Caribbean Away From Taiwan. The Washington Post,
February 27, 2005. pg. A.22. Edward Cody. China’s Quiet Rise Casts Wide Shadow; East
Asian Nations Cash In on Growth, The Washington Post, February 26, 2005. P. A1.
29 President Chen’s remarks of August 3, 2002, at the 29th Annual Meeting of the World
Federation of Taiwanese Associations.
30 Pan, Philip P. China Puts Threat to Taiwan Into Law; Move Could Reverse Recent
Warming in Cross-Strait Relations. Washington Post, March 14, 2005. P. A1.

in China’s military capabilities, the cross-Strait balance of power is steadily shifting
in Beijing’s favor.31 For Taipei, the strategy is to maintain “effective deterrence”
through “resolute defense” and to avoid having the military balance tip toward
Beijing.32 Taiwan’s Ministry of National Defense, in its biennial defense report,
places the possibility of a direct attack by the PRC across the sea as low, but warns
of the PRC military buildup and the likelihood that an imbalance in the PRC’s favor
may induce Beijing to attempt to resolve the Taiwan issue through military means.33
The critical deterrence factor against military action has always been the weight
of war damage and possible intervention by the United States. These factors still are
preeminent, but the diplomatic, political, economic, and human costs of open
hostilities have reached a level far beyond that of years past when China was more
isolated and less interconnected with the rest of the world.
Some in Beijing have indicated that they would fight to retain Taiwan regardless
of cost. In December 2003, a leading Chinese military strategist warned that a
decision to attack Taiwan would not be affected by concerns about China’s economic
development and that Beijing was not concerned that foreign investment might drop
or that an attack would set back its development by several years.34 China’s 2004
report on national defense states that Taiwan’s independence movement is the
greatest threat to China’s sovereignty and is something that must be stopped “at any
cost.”35 These references to the cost of open conflict with Taiwan seem to reflect the
growing tension within China between the military and business and international
trading sectors. A Chinese observer in a think tank in Shanghai, moreover, cautions
that even though economic and financial ties are having a positive effect on security
ties, in reality, the effect still is small. Right now it is more “hope than reality.”36
The fact that China has not resorted to force to achieve one of its major national
goals, however, indicates that Beijing currently can ill afford overt hostilities. The
military deterrent, of course, is always in play, but as seen from the Taiwan side,
other considerations are causing stability in the cross strait relationship to continue.
First, the Chinese need stability to continue economic development, attract
investment and deal with the challenges of WTO accession as well as with domestic
problems such as unemployment and the urban-rural divide. Second, the

31 U.S. Department of Defense, FY2004 Report to Congress on PRC Military Power, Annual
Report on The Military Power of the People’s Republic of China, May 28, 2004. p. 46.
32 Republic of China. Ministry of National Defense. Statement of Policy for the MND,
November 17, 2004. Note: Taiwan’s foot-dragging on purchases of arms from the United
States is a sore point in U.S.-Taiwan relations. Taiwan still has not provided funding for
weapons approved for purchase in 2001.
33 MND Issues New Defense White Paper. Taiwan Update, December 23, 2004, Vol. V,
No. 13. P. 5.
34 Pomfret, John. China’s Military Warns Taiwan. The Washington Post, December 4,

2003. p. A25.

35 People’s Republic of China. China’s National Defense in 2004, December 27, 2004.
Chapter II.
36 Interview at the Pudong Institute on the U.S. Economy in Shanghai, January 28, 2005.

international business community also wants stability in the region for business
reasons — a message they have conveyed to both Beijing and Taipei. A third reason
is that Taiwan also needs stability to conduct its own internal political and economic
reforms.37 Hence, neither side is opting for overt hostilities.
The Taiwan side points out, however, that whether the growing economic
interdependence across the strait combined with other deterrent forces leads to
stability or instability depends on whether Beijing’s decision makers are rational or
irrational. If they are rational (as viewed by Taiwan), a cost-benefit analysis would
likely overrule an unprovoked military action against Taiwan. If they are irrational
(as viewed by Taiwan), however, anything can happen. History has shown that in
campaigns, such as the 1966-76 Cultural Revolution, rationality (as might be viewed
by others) does not always prevail in Beijing.38
One author who has examined the integration of the information technology
industry between Taiwan and the PRC concludes that in addition to the fatalities and
casualties resulting from open hostilities, a cross-Strait war would devastate
Taiwan’s economy and severely harm China’s industrial progress. He points out that
such a war also would cripple the digital economies of every developed economy in
the world. His argument is that all international commerce depends on silicon-based
computer and communications systems, while industries depend on new information
technology products for future productivity gains. A cross-Strait war would suddenly
cut into much of the world’s supply of silicon-based products essential for global
commerce and investments in new technology. The author surmises that any use of
force to reunify China would cause such a jolt to the world economy that the United
States would be forced to intervene preemptively to prevent it.39
Another study points out that China’s desire to attract investment and
technology from Taiwan is likely to decrease the likelihood of conflict in the Taiwan
Strait by “making the costs of any potentially provocative move prohibitively high
for both sides.” In short, economic integration has made war so costly that neither
side would “risk contemplating any action that might ignite a serious conflict.”40
In a separate study, a Taiwanese professor points out that while cross-Strait
integration has generated spill-over effects in terms of broadening exchanges to areas
untouched in the past, economic integration has not resolved the sovereignty issue.
It also, in his view, has precluded the Chen administration from making bolder
moves toward independence because of Taiwan’s dependence on the Chinese market.
This professor believes that Beijing has become more confident and assertive and

37 Meeting between delegation of American scholars and Tsai Ing-Wen, Chairperson,
Mainland Affairs Council, in Taipei, January 9, 2003.
38 Interview with David Huang, Mainland Affairs Council, in Taipei, January 30, 2005.
39 Addison, Craig. Silicon Shield, Irving, TX, Fusion Press, 2001. P. x-xi.
40 Chase, Michael S., Kevin L. Pollpeter, and James C. Mulvenon. Shanghaied? The
Economic and Political Implications of the Flow of Information Technology and Investment
Across the Taiwan Strait. Rand, National Defense Research Institute Technical Report, TR-

133, July 2004. P. 145.

appears willing to promote economic and other exchanges without attaching political
strings as was the case previously. As it gains economic power, Beijing is feeling
“more comfortable in relying on economic means to achieve its political goals.”41
Former National Security Advisor Henry Kissinger sees a type of historical
evolution taking place as more and more of the Taiwanese economy is connected
with the PRC and more and more exchanges take place. Over a period of ten years
or perhaps more, he says, the conditions of life on the two sides of the Taiwan Strait
will become more comparable, and the dialogue on the political level, therefore,
easier. He does not feel the problem will be resolved by economic exchanges, since
peace across the Strait depends on a political solution and an understanding of what
is required for peace in Asia.42
Many military authorities continue to emphasize the risk that a cross-Strait crisis
could trigger a global conflagration. What can be concluded is that the stakes of
overt hostilities are now higher and that the cost-benefit calculation extends over all
levels of interaction — not just the military.
The bilateral relationship between China and Japan is shifting dramatically.
There is growing and consistent interaction at the human and economic level shaded
by considerable political friction and historic tension as well as occasional naval
clashes. As depicted in Figure 7, the temperature of interaction at the human and
individual level is mixed. Communication and cultural exchanges tend to be warm,
but anti-Japanese sentiments and nationalistic incidents in China continue emphasize
the iciness of human relations. At the economic and financial level, however,
relations are hot. These comprise the bulk of interaction, are self motivating, and
take place without much official notice or fanfare. At the diplomatic and political
level, relations are tepid — not warm but not cold either. China is supplanting Japan
as the leader in Asia, and Japan is having to cede diplomatic territory to Beijing.
Many in Tokyo are taken aback at what they consider to be high handed actions by
Chinese leaders and their use of historical animosities that many in Japan feel are43
generated by the government-controlled Chinese press and educational system.
Prime Minister Koizumi of Japan has taken some actions that rile Beijing to
underline the point that Japan is a leading industrialized nation and acts according to
its own interests despite objections from China. At the military level, relations are
cold as both countries seek to establish their claims to offshore islands and Japan
watches the Chinese military buildup with deep apprehension.

41 Chao, Chien-Min. National Security vs. Economic Interests: Reassessing Taiwan’s
Mainland Policy under Chen Shui-bian. Journal of Contemporary China, November 2004,

13(41), pp. 697, 702.

42 Public Broadcasting System, Frontline, Dangerous Straits, interview with Henry
Kissinger. Early autumn, 2001.
43 Interviews by the author in Tokyo, January 2005.

Figure 7. Temperature, Strata of Interaction, and Influence in
Relations Between the People’s Republic of China and Japan
PRC's Influence With JapanJapan's Influence with the PRC
US Alliance, Defense Forces
Military (Cold)
Maritime Incursions, Nuke Power
Leadership, Shrine Visits
Diplomatic/Political (Cool)
WW II Legacy, Diplo. Pressures
JapanPRCTrade, Investments
Economic (Hot)
Trade, Investments
Nationalism, Communications
Human/Individual (Mixed)
WW II Sentiments, Communications
Congressional Research Service
As discussed previously, trade and investment relations have surged in recent
years. Japan’s economic recovery has been maintained partly by exports to China,
and Japan’s businesses also have incorporated China as an important manufacturing
platform for their products. Including Hong Kong, Japan now trades more with
China than with the United States. Statements by both Beijing and Tokyo indicate
the desirability of mutually beneficial trade.
On the political side, however, tensions are high on a variety of historical and
sovereignty issues, and many observers see a potentially destabilizing spike in
nationalist animosity toward Japan among Chinese. Political and diplomatic
relations are intertwined with historical grievances, particularly those centered around
Japan’s behavior during and preceding World War II, that continue to surface in the
bilateral relationship. The most consistently divisive issue involves the visits of
Japanese politicians to the Yasukuni Shrine, a Shinto shrine in Tokyo that honors
Japanese who died in war. Those whose names are enshrined there include several
Class A war criminals. Chinese leaders have emphasized repeatedly that Prime
Minister Koizumi’s Yasukuni visits constitute a huge stumbling block in moving
political relations forward. On August 15, 2004, the anniversary of Japan’s surrender
in World War II, four cabinet level officials and 58 Diet members visited the
controversial shrine. In response, the Chinese Foreign Ministry stated that “the

political basis for China-Japan relations is for both nations to have a correct
understanding of that previous time.”44
In April 2005, large-scale anti-Japanese demonstrations broke out in at least
nine Chinese cities, including a violent protest in Shanghai that damaged the
Japanese consulate as well as shops that catered to the large Japanese expatriate
community. Many observers noted that the Chinese authorities were unusually
passive in allowing the protesters to organize, fueling speculation that Beijing quietly
encouraged the demonstrations to channel dissatisfaction at its own governance
toward a foreign target.
Koizumi’s fifth annual visit to Yasukuni on October 17, 2005, again drew angry
protests from Asian leaders: both Beijing and Seoul cancelled upcoming bilateral
meetings with the Japanese, but in China no widespread anti-Japanese
demonstrations occurred. Some observers noted attempts by Koizumi to tone down
the symbolism of the visit with less formal clothing and ceremony, perhaps as a
concession to domestic pressure from pro-business interests who fear antagonizing
China. Koizumi may also have been responding to an Osaka High Court ruling
earlier in the month which claimed that his visits as Prime Minister to Yasukuni
constituted a violation of the constitutional separation of church and state. Some
reports have noted that the existing separation of church and state has been weakened
in the draft revision of the constitution recently submitted by the governing LDP.
Since the mid-1990s, Tokyo and Beijing have feuded over Japanese history
textbooks for school children. China and other Asian countries insist that the texts
misrepresent Japan’s past by downplaying the atrocities committed by Japanese
soldiers against civilian populations. When then-President Jiang Zemin visited Japan
in 1998 — the last time a head of state of either country visited the other — he
warned the Japanese hosts not to forget history.45 Furthermore, Japan’s campaign to
gain a permanent seat (without veto power) on the United Nations Security Council
is facing opposition from Beijing.46
Even brushing aside disputes over territory and history, the medium and long-
term outlook for stable security relations is uncertain. Recent Japanese defense
documents and officials have cited concern about China’s ongoing military
modernization. Japan’s Defense White Paper noted a need to pay attention to the
modernization of China’s People’s Liberation Army (PLA). In writing Japan’s
National Defense Program Outline (NDPO) for 2004, three scenarios in which China
attacks Japan were posited: a confrontation over marine resources, territorial conflict

44 James J. Pryzstup. “Not the Best of Times,” Comparative Connections, 3rd Quarter 2004.
45 “Asian Enmities,” Washington Post. August 29, 2004.
46 Lynch, Colum. China Fights Enlarging Security Council, The Washington Post, April 5,
2005. P. A.15. Anti-Japan Protests Spread to Shenzhen; Thousands Take to Streets to
Challenge Tokyo Bid for UN Security Council Seat, South China Morning Post, Hong
Kong, April 4, 2005. P. 9.

in the Senkaku Islands, and an extension of a China-Taiwan conflict.47 Japan’s
military thinkers, however, view a direct invasion of the Japanese mainland as quite
unlikely at this time.48
A variety of other sensitive sovereignty issues have dominated recent bilateral
relations. On November 10, 2004, the Japanese Maritime Self Defense Forces were
sent to interdict and track a Chinese nuclear submarine that had been detected in
Japan’s territorial waters close to Okinawa. The incident prompted harsh criticism
from both the ruling and opposition parties in Japan. Maritime research activities
conducted by China in the East China Sea near the Exclusive Economic Zone (EEZ)
claimed by Japan alarmed Tokyo and sparked debate during Japan-China ministerial
talks. Expressing concern that China’s development of natural gas fields would
laterally siphon off resources from Japan’s claimed territory, Japan began its own
survey activities in July 2004. China has also reportedly carried out other naval
activities which have crossed into Japan’s EEZ, prompting some lawmakers to call
for an increase for Japan’s Coast Guard to protect the area around the disputed
Senkaku/Diaoyu islands. In October 2005, there were reports that China completed
construction on and had begun operating at least one new drilling platform in the
contested area.
Shinzo Abe, Deputy Secretary General of the ruling Liberal Democratic Party
in Japan, has been quoted in press reports as saying, “the conventional wisdom is to
regard China as a threat on the military front.” In addition, many analysts say that
Japan’s adoption of a missile defense system, as outlined in the Araki Commission
report, creates a fundamental strategic conflict with China. In a separate
development, following ministerial meetings in Washington, DC on security, the
United States and Japan stated that a common strategic objective was to “encourage
a peaceful resolution of issues concerning the Taiwan Strait through dialogue.”49
This was a rare statement by Japan of its interest in stability across the Strait and was
viewed in Beijing as “brazenly interfering in China’s internal affairs.”50 Beijing also
has criticized the strengthening U.S.-Japan security relationship even as the three
countries work together in the Six-Party Talks to deal with North Korea’s nuclear
weapons programs.
An obstacle to improved relations may also be a rising tide of nationalism
among young Chinese. Although China’s indignation at Japan’s military occupation
of the country in the 1930’s and 1940’s has long been expressed by the state-
controlled Chinese press, observers have noted a rise in anti-Japanese fervor among
the younger generation. Hostility towards the Japanese crystallized at the Asia Cup
soccer finals in August 2004, when Chinese fans yelled violent anti-Japanese chants,

47 “Agency Anticipates China Attack on Japan,” Tokyo Shimbun (translated by US Embassy
service), November 8, 2004.
48 Interviews at Japan Maritime Self Defense Force Staff College, Tokyo, January 25, 2005.
49 U.S. Department of State. Joint Statement of the U.S.-Japan Security Consultative
Committee, Washington, DC, February 19, 2005.
50 Xinhua Daily Telegraph as cited in U.S. Department of State, INR, “Issue Focus: U.S.-
Japan Joint Security Statement: Concerns over an ‘Emerging China.’” February 24, 2005.

threw bottles at the team bus, and burned the Japanese flag outside Japan’s embassy
in Beijing. Rising Internet usage may also play a role as networks of young
nationalists have formed online.51 In another example, isolated remarks by the
governor of Kanagawa Prefecture that Chinese holding student visas were “sneak
thieves” spread quickly over the Internet through Chinese chat rooms.
A Japanese observer of major trends sees China as the single most formidable
challenger to Japan. Although private economic relations are thriving, he sees rising
friction at the government level. The two countries maintain a type of “cold peace,”
as China matures and attempts to reclaim its position in the world.52
Despite considerable tension between the political leadership, however, there
appears to have been greater efforts to handle conflict and discord in the past few
years. China’s Vice-Foreign Minister reportedly expressed regret for the November
2004 submarine incursion into Japanese waters, citing “technical problems” that had
caused the submarine to veer accidentally into Japanese waters.53 In 2004, three of
the thorniest wartime-related issues were resolved, generally in favor of the Chinese
side. In the courtroom, the Hiroshima High Court awarded full damages to Chinese
wartime forced laborers based on the violation of the plaintiffs’ human rights. In a
second case, a company settled with another group of Chinese wartime laborers on
similar charges. After the Chinese Foreign Ministry complained to Japan that
artillery shells from the Japanese Imperial Army were still injuring Chinese citizens,
Japan acknowledged that the shells belonged to its erstwhile army and dispatched a
weapons excavation team to central China.
Other government initiatives have suggested a priority on bettering bilateral
relations. China’s ambassador to Japan, Vice-Foreign Minister Wang Yi, is
considered to be a potential future foreign minister, and is particularly well-regarded
as an Asian specialist. Japan also recently expanded Chinese citizens’ eligibility for
15-day tourist visas to visit Japan. Although Koizumi and Hu have not exchanged
bilateral visits, they have met on the sidelines of other international meetings.
Parliamentary exchanges also have been active, with over 100 representatives from
both the LDP and Democratic Party visiting China following the 2004 Diet session.
House of Representatives Speaker Yohei Kono received the red carpet treatment and
met with top leaders in Beijing in September 2004.
The rocky patch in Sino-Japanese relations coincides with the United States
asking more of Japan’s military, including an overseas deployment to Iraq and active
involvement in supporting coalition forces in the Afghanistan theater. Much of
Japan’s defense establishment has embraced the concept of Japan’s defense forces
becoming more active in maintaining regional and global stability. Many Chinese
officials view the developments warily, particularly the anticipated debate in Japan

51 Lynch, David J. Animosity Toward Japan Is Again the Rage in China; Past Brutality,
Modern Disputes Feeding Nationalist Movement, USA Today, February 24, 2005. P. A8.
52 Taniguchi, Tomohiko. Major Trends in Japan. Slide presentation, December 2004.
53 Cody, Edward. Beijing Explains Submarine Activity; Japan Considers Account an
Apology. The Washington Post, November 17, 2004. p. A.22.

on amending Article 9 of the constitution, which renounces the use of force to settle
Analysts surmise that internal debates on how to best approach the regional
rivalry go on in both capitals. In Tokyo, the disagreements are more transparent:
figures such as former LDP Secretary General Koichi Kato and House of
Representatives Speaker Yohei Kono have both publicly urged Koizumi to take
China’s concerns into consideration when deciding to visit Yasukuni Shrine. During
Kono’s visit to Beijing in September 2004, he expressed regret that the bilateral
relationship was far more mature economically than politically.54 In Beijing, the
debate is carried out in less explicit ways. Some government-affiliated think tanks
have advocated a more practical, less emotional approach to relations with Japan.
The Strategy and Management Journal ran a series on Sino-Japanese relations in
2003 that highlighted the economic importance of the relationship and suggested a
need to move beyond historical disagreements. However, some observers say that
Chinese policy-makers, constrained by simmering public resentment towards Japan,
are unwilling to take the political risk of appearing “soft” on Japan. Others surmise
that Beijing uses anti-Japanese sentiment and allows popular demonstrations as a
means to enable Chinese to “let off steam” rather than direct their frustrations and
anger toward the ruling communist party.
Economic competition between China and Japan also is playing out in various
ways upon the international scene. In view of China’s increasing economic muscle
and diplomatic friction with Japan, in 2005, Tokyo informed Beijing that it plans to
phase out its yen aid loans (actually a form of war reparations) by 2008. These loans
comprise some 90% of all Japanese aid to China and seem unnecessary for a country
that itself is becoming a major aid provider.55 Also in 2004, Russia chose Japan over
China as a future oil customer by announcing that it would build a pipeline carrying
Siberian oil to a Japan Sea terminus instead of to China.56
In Japan, economics and politics always have mixed. In many respects, the U.S.
nuclear umbrella has allowed the country to pursue “checkbook diplomacy” by which
Tokyo has used its trade, aid, and investments along side the strengthening of its
military to develop what they have called comprehensive security. Japanese
experience in the 1980s showed that while economic interdependence may not
deflect trade and political friction, it puts incentives in place to resolve disputes

54 “Japan, China Need Harmony, Not Antagonism: Japan’s House Speaker,” Xinhua News
Agency. September 23, 2004.
55 Such aid peaked at 214 billion yen (about $2 billion) in 2000. “Japan Has Notified China
That it Intends to Terminate the Extension of Yen Loans in Fiscal 2008, Citing the
Country’s Remarkable Economic Development, It Was Learned Thursday.” Jiji Press
English News Service. Tokyo, March 3, 2005. p. 1
56 Watkins, Eric. Japan, Russia Start Talks on Oil Pipeline Details, Oil & Gas Journal,
January 24, 2005. Vol. 103, Issue 4. p. 26.

amicably. Economic and financial relations formed a base from which Japan could
approach diplomatic, political, and security relations with other states.57
For both Japan and China, one key question is to what extent the extensive
economic interactions and diplomatic sensibilities will prevent political tension from
escalating into outright hostility or even military conflict. Some experts point to
tentative evidence that Japan-China security relations are stabilized by growing
economic ties. One study of the Sino-Japanese relationship concludes that
cooperation in the economic realm has not developed into cooperation in the security
realm, but the author also notes that confrontation in the security realm also has not
brought friction in economic relations. Japan’s China policy is striking a balance
between military security and commercial policy.58 Another study concludes that
economic interaction has, on the whole, proven effective in promoting stable political
relations. The economic nexus has not only provided the foundation for the political
relationship, but it has served to maintain that relationship during times of trouble.
In times of crisis (such as the 1989 Tiananmen Square crackdown), Japan’s political
retaliation was scant so as not to disturb the economic synergy and political stability.
The author also concludes that as the two economies become more profoundly
intertwined with each other, they are likely to reach out to each other in areas such
as regional security affairs in order to maintain the peace.59 One example of such
cooperation could be China’s cooperation with Japan (and the United States, South
Korea, and Russia) in the Six Party Talks on North Korea.
In short, economic interaction appears to have induced the two sides to keep the
political rhetoric to a manageable level and adroitly tiptoe around potential military
clashes. Both sides, however, continue to build their military capabilities. The
question, then, becomes whether economic and cultural ties will continue to induce
military restraint as China grows into a major regional power and Japan begins to
deploy its military outside of its homeland defense perimeter. Another question is
whether economic and cultural ties will overcome historical animosities or whether
economic ties, themselves, will become a target of boycotts and popular
demonstrations in either country.
The relationship between China and South Korea (The Republic of Korea or
ROK) provides a model for how deepening economic relations can bring two capitals
together politically. Figure 8 outlines the major strata of interaction, channels of
influence, and the temperature of relations between the PRC and South Korea. As
is the case with Japan, the major daily interaction is in communications and

57 Matthews, Ron. Business Focus Turning Point for Japan, Jane’s Defence Weekly, May

29, 1993.

58 Choi, Woondo. Persistence and Change in Japan-China Relationship. Journal of
International and Area Studies, 10(1), 2003, p. 90.
59 Burns, Katherine G. China and Japan: Economic Partnership to Political Ends, Economic
Confidence-Building and Regional Security, edited by Michael Krepon and Chris Gagnè,
The Henry L. Stimson Center, 1999. P. 56-57.

economics while disputes over historical issues occasionally cloud the relationship.
At the human and individual level, the temperature of relations is mixed with rising
warmth in cultural exchanges and communications but occasional cooling in
nationalistic disputes. Cultural ties have also increased multifold: tourism in both
directions has increased markedly, and the number of South Korean students studying
Mandarin has skyrocketed. Historical ties between China and South Korea are not
as fraught as those between China and Japan, but disputes still surface.
The temperature of economic and financial relations has been hot as China has
displaced the United States as South Korea’s major trading partner, and South
Korean businesses have moved labor-intensive production processes to Chinese
factories. Each economy has grown increasingly dependent on the other for trade and
investments. In 2004, South Korea exported $49.8 billion in goods to China, $42.8
billion to the United States, and $21.7 billion to Japan, while importing $46.1 billion
from Japan, $29.6 billion from China, and $28.8 billion from the United States.60
Figure 8. Temperature, Strata of Interaction, and Influence in
Relations Between the People’s Republic of China and South Korea

PRC's Influence With S. KoreaS. Korea's Influence with the PRC
US Alliance & Bases
Military (Cool)
Alliance with N. Korea, Nukes
Engagement, Relat. w/ N. Korea
Diplomatic/Political (Warm)
6-Party Talks, Rel. w/ N. Korea
Trade InvestmentsS. Korea
Economic (Hot)
Trade Investments
Nationalism, Communications
Human/Individual (Mixed)
Communications, Nationalism
Congressional Research Service
At the diplomatic and political level, relations have generally been warm
(cordial) since the normalization of ties in 1992, but disputes over treatment of North
Korean refugees seeking passage through China and other issues have sometimes
cooled relations. Frequent reciprocal visits by top officials have solidified the
60 Korea International Trade Association (KITA) [ ].

political relationship, and cooperation in attempting to resolve the North Korean
nuclear crisis has gained Beijing further favor in Seoul.
Korea’s history with China is not always viewed as a positive influence on
contemporary bilateral relations. A controversy in 2004 over the origins of the
Koguryo Kingdom sparked a major political dispute, the largest since the
normalization of relations. The flap arose because of a PRC claim that the Koguryo
Kingdom (37 B.C. - 668 A. D.) was a part of Chinese territory and history, not, as
Koreans claim, an independent Korean entity that produced many of Korea’s long-
standing traditions. Angry reaction in South Korea came from many quarters,
including the public, members of the National Assembly from both parties, and the
Ministry of Foreign Affairs and Trade. Many claimed that the controversy exposed
Beijing’s “hegemonic ambitions,” and erased an earlier impression of China as a
benevolent economic partner.61 Officials on both sides scrambled to calm the
controversy and Beijing dispatched Vice Minister Wu Dawei, former ambassador to
South Korea, to negotiate a resolution. The resulting five-point agreement soothed
Korean concerns at least temporarily. With the North Korea problem still at a
sensitive stage, government officials were relieved to patch up the relationship. Still,
the incident exposed strong underlying sentiment in both populations and could
indicate a shift away from the cozy political relationship the two capitals enjoyed for
over a decade since normalization.
At the military and security level, relations are cool but warming. Despite
China’s intervention in the Korean conflict and alliance with North Korea, security
relationships between Seoul and Beijing are improving. In 1999, China and South
Korea agreed to hold annual discussions on regional security issues.62 China holds
a large wild card in the security relationship because of its influence with Pyongyang.
Similar to Japan, however, South Korea also is concerned about the potential adverse
behavior of China two or three decades into the future when it is expected to achieve
major power status.
The threat of instability posed by the North Korean nuclear program has induced
the major powers in the region to cooperate in bringing Pyongyang to the negotiating
table. These six-party talks build on common security and economic interests and
have brought the governments of China and South Korea into a loose partnership.
Both countries oppose the development of a nuclear arms program by North Korea.
Each fears the consequences of a collapsed Kim regime in Pyongyang which could
create instability for their own governments. Because Japan generally has hewed
closely to the more hardline U.S. position, Seoul and Beijing have found themselves
advocating a similar approach of engagement and laying out in explicit terms what
Pyongyang could gain if it abandoned its nuclear weapons program. Observers note
the irony that with respect to the North Korean nuclear issue, Sino-North Korean
relations have become somewhat of a burden for Beijing while ties with South Korea
have become economically beneficial. The two countries have found this common

61 Snyder, Scott. “A Turning Point for China-Korea Relations?” Comparative Connections,

3rd Quarter 2004.

62 Foley, James A. “China Hedges Its Bets on North Korea,” Jane’s Intelligence Review.
November 1, 2004.

ground despite strong disagreement on how to handle current North Korean refugees
who try to defect to third country embassies in China in attempts to gain passage to
South Korea.
As in the case with Japan, the U.S.-South Korean military alliance weighs
heavily on the growing ties between Beijing and Seoul. In essence, both have been
able to deepen the economic relationship with full knowledge that the United States
also seeks stability in Northeast Asia. China and South Korea’s cautious political
alignment on the six party talks has taken place, however, as cracks have begun to
appear in the U.S.-South Korea alliance. With the election of President Roh Moo-
Hyun and the subsequent victory of his Uri Party in the National Assembly elections,
some in South Korea and elsewhere have seen a shift from Washington to Beijing as
Seoul’s favored partner both economically and diplomatically. South Koreans who
favor a stronger partnership with China point out the cultural and historical affinities,
economic interdependence, and the similar desire to maintain stability in the region,
including keeping Japan from resuming a more forward defense posture.
However, both Washington and Seoul policymakers insist that the alliance is
strong, and President Roh has kept his promise on sending troops to perform
humanitarian work in Iraq. Disagreements over the global realignment of U.S. forces
that will change U.S. military presence in South Korea appear to have been smoothed
over with further consultations and compromises. Although China may look like an
appealing alternative when relations with the United States waver, some observers
point to China’s history of shifting alliances, as well as its entry into the Korean War
in 1950 that ultimately preserved the division of the peninsula. Further, China has
not yet accepted Seoul’s 1999 proposal to hold joint maritime search and rescue
exercises,63 although talks have continued.
One indicator of the warming relations between Seoul and Beijing is the Roh
administration’s new geopolitical strategy (with the support of China) of seeking to
play the role of a balancing force in Northeast Asia. President Roh reportedly would
like South Korea to play the role of stabilizer for peace and prosperity and to place
exchanges between South Korea and China on the same level as those with Japan.
While Korean officials insist that ties with the United States remain unchanged,
concerns have been voiced that this strategy implies a shift toward China — possibly
because of policy differences with the United States.64
Expert studies also point to the growing strength of the economic relationship
in Chinese foreign policy. One expert concludes that since successful
implementation of reform and open-door measures for China requires stability,

63 Lee, Sung-yul. Korea, China Seek Military Exchanges and Cooperation. Korea Herald,
Aug. 24, 1999. P. 1.
64 Ahn, Sung-kyoo. Security Aide Explains Vision of Balancer Role. Seoul JoonAng Ilbo
(Internet version). April 14, 2005. (Reported by FBIS.) Seoul Downgrading U.S. Alliance
in Favor of Closer Military Ties with China, Russia. (subscription e-
mail service). April 12, 2005. ROK Presidential Committee Head Views ROK’s ‘Balancing
Role’ in Northeast Asia. Chosun Ilbo (Internet Version in Korean), April 12, 2005.
(Translated by FBIS).

Beijing has few options other than to pursue a pragmatic diplomatic policy rooted in
economic benefits, although clearly China shows no intention of compromising or
negotiating over matters related to its sovereignty. In this respect, China regards
peace and stability on the Korean peninsula as indispensable to its continued
economic advancement. It seeks to preserve the Pyongyang regime while taking
measures to resolve the North Korean nuclear problem. Also, the talk of
reunification between South and North Korea places pressure on Beijing to keep on
the good side of South Korea to avoid the prospect of a nuclear-armed, unified Korea
as an unfriendly neighbor. The PRC also would like to wean South Korea away from
its close military alliance with the United States in order to weaken what it views as
an important link in the U.S. “encirclement” of China. Beijing, therefore, has placed
great importance on its economic and trade relations with South Korea while
maintaining its support of Pyongyang and expanding diplomatic and political
contacts with Seoul.65
Policy Discussion
From the above discussion, it is apparent that the rise of the PRC as an
economic powerhouse has brought significant changes in China’s relationships with
Taiwan, Japan, and South Korea. The interests of all four of these governments are
being influenced by the rapid development of trade, investment, and financial flows.
These relationships are self-motivating, self-perpetuating, and self-sustaining. They
arise primarily out of the self interests of businesses and operate largely
independently of government intervention (except for government regulation,
ownership of enterprises, and financing). Many of these economic flows are
generated by the forces of globalization that are affecting all parts of the world.
Within the four strata of interaction (military, diplomatic, economic, and human),
economic relations between China and the other states are the warmest; human
interaction is both warm and cool; diplomatic relations range from warm to cold, and
military relations generally are cold or absolutely frigid.
The Chinese economy is growing so fast and becoming so large that other Asian
countries are jumping on the bandwagon to ensure that their industries both capture
some of the Chinese market and use the low-cost Chinese manufacturing platform
to keep their exports competitive in third country markets. Governments in the
region are increasing their economic engagement with China while hedging their bets
by strengthening their own military forces to offset the arms buildup in China. They
are keeping military clashes that do occur — often related to claims to disputed
islands — from escalating into political crises. China is increasingly engaging in
strategic cooperation, particularly in the global war on terrorism and in using its
influence with North Korea in hosting the six-party talks. Potential flashpoints,
however, still exist — particularly across the Taiwan Strait and with North Korea
— and a menacing frown could appear from behind China’s “smile diplomacy” once
the PRC modernizes its military and reaches its goal of becoming a mid-level
industrialized nation.

65 Kim, Taeho. The Rise of China and Korea’s Strategic Outlook. Korea Focus, 10 (3),
May-June 2002, p. 79-81.

Throughout northeast Asia, however, the costs of disrupting economic and
financial activity by a military or other crisis are rising. This is not to assert that
economic activity stops wars, since trade between Britain and Germany certainly did
not prevent either world war in the last century. The situation now, however, is
fundamentally different because industrial processes are integrated across countries;
financial markets are global; and people are more mobile. Disrupting economic
relations between Taiwan and the PRC, for example, not only would affect their trade
in computers, cell phones, and other final products, but it also would affect the global
information technology industry and production processes in other countries
(including the United States) that rely on China and Taiwan for critical components.
The main concerns with respect to rising Chinese economic power and the
growing trade and investment network in northeast Asia seem to be:
!China’s so-called “peaceful rise” is occurring below the radar screen
for many policymakers. China seems to be taking advantage of a
“distracted America” to build relationships with other countries that
could have far-reaching effects on U.S. interests and strategy.
!The growth of the Chinese economy is so rapid and broad-based that
it has the potential of fundamentally altering national interests
among countries. It already is affecting economic relationships both
among countries and within industries.
!China is displacing the United States as the primary trading partner
for many Asian countries. Everyone in Asia seems to be jumping on
the “Chinese bandwagon.” China’s market has become so extensive
that Taiwan, Japan, and South Korea have all joined the Chinese-
based economic network rather than try to work against it. While
the U.S. market will always be a major export destination, Japan,
South Korea, and Taiwan have progressively turned toward China
for imports and exports, and their companies increasingly are
dividing their manufacturing processes to take advantage of lower
costs in China.
!The progressively large economic and financial relationships
between China and its neighbors in northeast Asia is altering the
cost-benefit calculus of military action that might cause instability
in the region. The economic costs of instability are rising. Each is
being induced to seek stability, although the PRC is adamant in
preventing Taiwan’s independence.
!China’s growing economy provides the resources for Beijing to
modernize its military, and it is expected, before too long, to be able
to tip the balance of power across the Taiwan Strait in its favor.
Once that occurs, China may be willing to sacrifice external peaceful
relations to accomplish other national goals — such as forced
reunification with Taiwan.
!While the economic, political, and military relations in northeast
Asia occur largely on separate tracks, the sheer magnitude of the
economic flows is affecting relations at other strata of interaction.
Already, economic interests have induced more cooperation on
political disputes between China and Japan and South Korea. While
economic interests generally do not trump security interests, they

tend to induce countries to seek stability and refrain from taking rash
military or political actions that might lead to instability, sanctions,
surcharges in international financial markets, and other penalties —
whether imposed by the market or by foreign governments.
American interests in northeast Asia are a subset of the comprehensive U.S.
interests of security, prosperity, and value preservation. These translate into specific
U.S. goals of maintaining stability under a favorable balance of power, promoting
democracy and access to markets, and developing amicable and cooperative relations
with other nations. In China the ruling communist party has strong interest in
maintaining its hold on power, enabling rapid economic growth, maintaining
stability, and exercising sovereignty over what it considers to be its national territory.
Japan and South Korea seek security and stability in the region, particularly with
respect to North Korea and the growing military strength of China, rapid economic
growth, open trade and investment relations, as well as to maintain their
representative governments and systems of political pluralism. Taiwan shares
interests in economic security; it is distinguished by an all consuming focus on
maintaining cross-Strait stability. For the United States, a question is how to
promote and protect U.S. interests while northeast Asia undergoes rapid economic
During the Cold War, the countries of Northeast Asia and the United States
tended to make policy decisions relative to security, politics, and economics under
a bipolar strategic lens that placed security first in international relations. In most
cases, the overriding question for the West was whether the policy being considered
added to or detracted from the containment of the Soviet Union and curtailed the
spread of both Russian and Chinese-style communism. This colored, for example,
efforts to reconstruct post-World War II Japan, to intervene in the Korean conflict,
to provide support to the Republic of China on Taiwan, to escalate the Vietnam War,
to sometimes wink at trade barriers in Japan and South Korea in exchange for their
support of the U.S. military, and to promote closer trade ties with Japan and South
Korea rather than have them rely on China, their traditional trading partner. During
that time, the best predictor of whether a nation had amicable relations with the
United States was the degree to which it opposed communism. Now that the last
remnants of the Cold War are disappearing in Asia, national policy among countries
in Northeast Asia seems to be evolving more to reflect the practical interests of
individual states rather than their ideological bent. China’s Deng Xiaoping stated it
clearly when he said that it doesn’t matter if a cat is black or white, so long as it
catches mice.

Policy Choices for Congress
For Congress, the rise of China presents several geopolitical policy choices.66
These include what strategies the United States should pursue to accomplish long-
term interests given that the economic rise of China is likely to continue and what
combination of economic, diplomatic, and security measures should be employed to
best protect U.S. interests and accomplish particular U.S. policy goals.
The policy choices with respect to northeast Asia include whether to:
!continue current policies of promoting market economies, enabling
globalization, and encouraging democracy while projecting
sufficient military power to keep the peace in the region;
!seek to contain China along the same lines of the containment of the
former Soviet Union;
!actively counterbalance the rising economic influence of China and
the trading networks it is building by pursuing free trade agreements
and closer investment relations with Japan, South Korea, and
Taiwan and by strengthening free trade process under the Asia
Pacific Economic Cooperation (APEC) forum;
!bring China’s external trade more into balance, ensure that China
adheres to its World Trade Organization commitments, reduce the
foreign exchange resources available to China’s central government,
and slow the “bandwagon effect” by which Japanese, South Korean,
and Taiwanese businesses are establishing factories in China with
the intention of selling a part of the output in the U.S. market;
!facilitate the globalization of China in order to strengthen forces of
change, create centers of power outside of Beijing, and increase
representation in Beijing by business and international interests; and
!take into greater account the impact that the rise of China is having
on the policies of Japan, South Korea, and Taiwan.
Status Quo. Current U.S. policies toward the economic rise of China are
based both on “idealism” and “realism.” The Pentagon’s military planning, of
necessity, tends to be power- and threat-based and realistic. It considers and prepares
for several scenarios, including the “worst case” in order to provide for the security

66 For current legislation, see CRS Report RL32804, China-U.S. Relations: Current Issues
and Implications for U.S. Policy and CRS Issue Brief IB98034, Taiwan: Recent
Developments and U.S. Policy Choices, both by Kerry Dumbaugh; CRS Issue Brief
IB91121, China-U.S. Trade Issues, by Wayne M. Morrison; CRS Issue Brief IB98045,
Korea: U.S.-Korean Relations — Issues for Congress, by Larry Niksch; and CRS Issue Brief
IB97004, Japan-U.S. Relations: Issues for Congress, coordinated by Richard Cronin.

interests of the United States. Current policies stress contingent military planning,
export controls, strong alliance relations with Japan and South Korea, and rising
levels of engagement.
Other U.S. policies toward China tend to be idealistic. They are aimed at
promoting U.S. ideals of democracy, a liberal market economy, and human rights in
China. Many of these policies are based on the globalization-peace hypothesis67 that
posits a progression in the political and economic development of nations that starts
from a low-level agrarian economy that becomes globalized and enters a phase of
sustained economic development which then leads to the rise of a middle class
(mostly urban) and to greater internal demands for democracy and representative
government. The hypothesis posits that democratic governments do not fight each
other. Therefore, in this view, efforts to establish democracy ultimately lead to more
peaceful relations with other nations. This is one rationale for current U.S. policies
of liberalizing trade, facilitating China’s membership in the World Trade
Organization and other international institutions, encouraging communications at all
levels, and engaging Beijing on a multitude of fronts.
Containing China. Those who focus on the China threat often advocate a
policy of deterrence and containment — some have called it “constrainment.”68 This
is analogous to the containment doctrine pursued by the West during the Cold War.
While containment usually is couched in terms of military strategy, it also can extend
to economic and political issues.
Certainly, China’s economic rise has provided the resources for it to build a
modernizing and more powerful Chinese military. While the end of the Cold War
and rapproachment with Russia has reduced greatly the probability of a big-power
conflict in Asia, the rise of China as a regional nuclear power, in the minds of some,
merely shifts the threat to China. The PRC also looks toward the Pacific Ocean and
sees U.S. forces in South Korea, Japan, and Guam with the Seventh Fleet steaming
around Taiwan and Southeast Asia. China is one of the few nations actively arming
itself for a possible military confrontation with the United States.69 U.S. and
Japanese military planners are considering the implications of China as a military
power and, for example, the manner in which the two nations could address a70
possible China-Taiwan conflict. Discussion of U.S. military strategy with respect
to China, however, is beyond the purview of this report.
On the economic side, containing China is like trying to put a genie back into
a bottle. China’s economy already has broken loose from most of its moribund
communist strictures and has become well integrated into the global economic

67 This is an extension of the democratic-peace hypothesis.
68 Segal, Gerald. East Asia and the “Constrainment” of China, International Security, Vol.

20, no. 4 (Spring 1996).

69 Cody, Edward. China Builds a Smaller, Stronger Military, The Washington Post, April

12, 2005. P. A1.

70 Japan-U.S. Security Statement to Seek Greater Cooperation in the Asia-Pacific. The
Nikkei Weekly, December 27, 2004 and January 3, 2005, p. 6.

system. Since the late 1970s, the PRC has developed from an inward-looking,
protectionist economy to a world-class trading nation. Rather than China being
constrained, the PRC is using its economic ties and cross border investments to
ensure that its influence spreads. China is coopting its neighbors with its trade and
manufacturing resources. Taiwan is being forced to cope with the de facto
integration of its economy with the PRC, and Japan, despite historical enmity by the
Chinese people remnant from World War II, has little choice but to invest in China
and incorporate the Chinese market into its trade and investment strategy. South
Korea, despite the legacy of the Korean War and China’s support of the regime in
North Korea, has little choice but to enter the economic game with China. The
United States, likewise, is increasingly dependent on the Chinese market as a
manufacturing platform, an export market, and as a buyer of U.S. debt securities.
The Chinese economy is becoming the center weight of Asia. Any economy that
does not hook into it runs the risk of being left far out of the action. Measures
certainly can be pursued to ensure that China acts in ways consistent with its
international economic obligations, but the PRC seems to have moved beyond the
point where economic containment could be effective.
Counterbalancing the Rising Economic Influence of China. There
is little doubt that China is using its rising economic and political power backed by
its modernizing military to attempt to reduce U.S. influence in its periphery and to
establish itself as the central power in the region. This is not only because Beijing
has just now gained the resources to allow the country to flex its muscles with
credibility. A view in Japan and Taiwan, particularly among private-sector opinion
leaders, is that China is taking advantage of U.S. “inattention to Asia” to better
position itself to become the leader of Asia and to wean neighboring countries from
their dependency on Washington and move them toward Beijing. Those who express
this view assert that the United States needs to send a strong signal to countries in the
region that Washington is not distracted by the Middle East and that it has enduring
interests in Asia.71
There are many ways that signals can be sent. One is through realist channels
such as military strength and actual trade and investment flows. Another is through
idealist channels such as diplomatic and political contacts as well as multilateral
institution building. On the realist side, bolstering U.S. alliance relationships and
military capability as well as a full discussion of motives for U.S. troop reductions
(those in South Korea were interpreted by many in Asia as indicating a lower priority
for Asia than for Iraq) could be useful. Also, measures to increase U.S. trade and
investments in the region could help maintain or augment U.S. influence in northeast
If Japan, South Korea, and China continue to move toward a free trade
arrangement among themselves and with countries of Southeast Asia, the United
States may consider speeding up the initiation of discussions of bilateral free trade
agreements (FTAs) with Japan, South Korea, and Taiwan. While such FTAs would
not slow down the Chinese juggernaut, they might ensure that higher U.S. tariff rates
do not divert trade away from the United States and toward the region. While the

71 Interviews by the author in Tokyo and Taipei, January and February 2005.

relatively low levels of U.S. tariff rates (about 2%) make trade diversion not a
significant problem, the proliferation of FTAs in the region could create shifts in
trade flows away from the United States and toward the region. Of course, FTAs
involve many more issues,72 some negative and some positive, than just a signal to
The United States also may seek to reinvigorate the Bogor Declaration of the
Asia Pacific Economic Cooperation (APEC) forum under which 21 economies
bordering the Pacific Ocean are working cooperatively to reduce barriers to trade and
investment; ease the exchange of goods, services, resources, and technical know-
how; and strengthen economic and technical cooperation. In the 1994 Bogor
Declaration, the leaders of APEC declared their intention to establish free trade and
investment in the region by the year 2010 for industrialized members and 2020 for
the others.73 In essence, the Bogor Declaration would create a huge Asia-Pacific FTA
that would include both the United States and China.
China’s rising economic influence is occurring primarily at the expense of
Japan. Despite the fact that Japan still has the second largest economy in the world
(third if the European Union is counted as a single economy74) and has a gross
domestic product three times as large as China’s, a decade and a half of recession has
diminished the rising Japanese economic star considerably. Efforts to restart
Japanese economic growth and to induce Tokyo to take a stronger leadership role
could offset some of China’s allure as a regional leader.
Bringing China’s External Trade More into Balance. The United States
could work more with nations of Asia and Europe to bring China’s external trade75
more into balance. Although China claims that it ran a surplus in 2004 of $33
billion in its merchandise trade with the world, the United States alone incurred a
deficit of $162 billion and the European Union (15 countries) a deficit of $63 billion
with China. Even when taking China’s surplus of $89 billion with Hong Kong —
much of which is entrepot trade that is trans-shipped to other nations, China’s
reported trade surplus seems to be understated. For 2005, preliminary data indicate76
that China’s trade surplus tripled to $102 billion. Regardless of the exact trade
figures, more might be done to ensure that China adheres to its World Trade

72 For further information on FTAs, see CRS Report RL31356, Free Trade Agreements:
Impact on U.S. Trade and Implications for U.S. Trade Policy, by William H. Cooper.
73 See CRS Report RL31038 Asia Pacific Economic Cooperation (APEC), Free Trade, and
the 2004 Summit in Santiago, Chile, by Emma Chanlett-Avery. APEC members include the
United States, Canada, Mexico, Chile, Peru, Japan, South Korea, China, Taiwan, Hong
Kong, Indonesia, Brunei, Malaysia, Singapore, Thailand, the Philippines, Vietnam,
Australia, New Zealand, Papua New Guinea, and Russia.
74 GDP in 2003 for China was $1.4 trillion, for Japan was $4.3 trillion, for the United States
was $10.9 trillion, and for Germany was $2.4 trillion.
75 For discussion of this issue, see CRS Issue Brief IB91121, China-U.S. Trade Issues, by
Wayne M. Morrison.
76 Mcgregor, Richard. China’s Trade Surplus Triples to Record Dollars 102bn. Financial
Times (London), January 12, 2006, P. 7.

Organization commitments (especially enforcement of intellectual property rights)
and allows more flexibility in its foreign exchange rate (to reduce China’s trade
surplus and the dollar assets available to China’s central government). A higher
value for China’s currency also could dampen the lure of the Chinese economy as a
low-cost manufacturing platform that causes a “bandwagon effect” by which
Japanese, South Korean, and Taiwanese businesses establish factories in China with
the intention of selling a part of the output in the U.S. market. These measures may
not slow down China’s growing trade and investment network, but it could help to
ensure that trade is conducted according to world standards.
The current attention on the upward valuation of the Chinese yuan is a separate
topic that is receiving considerable attention already.77 At a time that the U.S. dollar
is depreciating in response to the U.S. current account deficit of around 6% of GDP,
the peg of the yuan to the dollar shifts the burden of adjustment to Europe, Japan,
South Korea, and other countries. What is particularly ironic is that the bilateral U.S.
trade deficit with China at $162 billion is not subject to the market forces normally
exerted by exchange rate adjustment. Also, since the Japanese yen and South Korea
won already are floating, the Chinese peg to a declining dollar gives Chinese exports
a relative price advantage not only in the American market but in Japan and South
Korea as well. Between January 2002 and January 2005, the dollar depreciated 22%
against the Japanese yen and 20% against the South Korean won. Since the Chinese
yuan has been tied to the dollar, it too has depreciated by like amounts against the yen
and won. This gives Chinese exporters an artificial advantage in Japanese and Korean
In 2005, Beijing announced that it had dropped its currency peg. China said it
had revalued the renminbi by 2.1% from 8.28 yuan to 8.11 yuan per dollar and that
its currency would be “referenced” to a basket of currencies and allowed to fluctuate
within a 0.3% trading band around the U.S. dollar. The main components of the
reference currency basket consist of the dollar, euro, yen, and Korean won, but the
relative weights of each were not revealed. Since July 2005, there has been little
further appreciation of the yuan.
Facilitate Globalization/Democracy. The United States could encourage
even more globalization in China in order to foster internal change. The forces of
globalization and economic development in China are causing fundamental shifts in
power and interests. Irrespective of whether the rise of China’s business and working
class (as opposed to peasants and the military) will lead to an end to one-party rule,
it is clear that the ruling Chinese Communist Party (CCP) is being compelled to pay
greater attention to business and worker interests. The CCP has attempted to coopt
these interests by allowing businessmen to join the party and by seeking to broaden
representation to include all segments of society.
In addition to ceding space in its decision making process to industrial interests,
the current CCP leadership is coming into power with experience in the
transformation of society that comes from development and modernization after

77 See CRS Report RL32165: China’s Exchange Rate Peg: Economic Issues and Options
for U.S. Trade Policy, by Wayne Morrison.

opening to the outside world. The core of Chinese leadership has progressed from
revolutionaries, to technocrats, to educated administrators and politicians. For these
people, the country’s dependence on international investment and trade for the
economic growth needed to maintain the party’s legitimacy has become an important
consideration in policy making — including security policy. Still, over the long term,
whether this will induce Beijing to pursue policies of stability in security
relationships and to open its society even further to international forces is yet to be
Globalization also is creating stresses with Chinese society that could spell
trouble for Beijing. Widespread inequality in incomes both between the rich and
poor in particular regions and the gaping gulf in wealth and income between the
coastal and inland provinces could cause unrest. Without the recent rapid economic
growth, the rising ranks of China’s unemployed would have been even larger. These
unemployed in combination with a poor social safety net, dangerous working
conditions in many industries, corruption, and religious repression generated about
160 public protests per day in 2003.78 Rapid economic growth in China may lead to
more democracy, but it also could lead to civil disorder and repression. One policy
question is how to encourage alternative power bases outside of the Chinese
Communist Party and to sympathize with assorted public protests without inviting
another Tiananmen Square type of crackdown. The United States is steering a fine
line between partnership and pressure in supporting democratic forces in China.79 In
this endeavor, enlisting more support from Japan and South Korea could be useful,
and the constant flow of information into China on democracy in Taiwan (and Hong
Kong) can not help but have an accumulating effect on perceptions across the Strait.
Third Country Policies. The rise of China is having decided effects on the
policies of Japan, South Korea, and Taiwan. Bilateral relations between these states
and China tend to divide into strata with economic relations charging ahead while
security and political relations lag behind. The economic and financial activity,
however, is affecting security interests. In the six-party talks with North Korea, for
example, the United States has had to rely on the good offices of China with
Pyongyang and to accommodate South Korea’s policy goals, which in some areas,
seem to coincide more with those of Beijing than those of the United States. Another
example is the movement by East and Southeast Asian nations to organize into a free
trade area (ASEAN + 3) that includes China but excludes the United States. This
East Asian Community based on a regional trade and financial system already is
helping to induce Asian nations to invest in local and European currencies as reserves80
rather than the dollar.

78 Two Concepts of Liberty? The Economist (London), March 5, 2005. P. 12.
79 U.S. efforts to promote democracy in China include bilateral diplomatic efforts,
multilateral action, and support through government and nongovernmental channels. The
United States also seeks to strengthen China’s judicial system, further the rule of law, and
encourages democratic political reform. See U.S. Department of State, Supporting Human
Rights and Democracy: The U.S. Record 2004 - 2005. March 28, 2005.
80 Miyauchi, Teiichi. U.S. Wary as East Asian Community Nears Reality. The Nikkei
Weekly, December 13, 2004. P. 27

This is not to say that U.S. influence is still not great in the region. China
realizes that forcing Asian states to choose between Beijing and Washington can be
counterproductive — particularly those tied to the United States with security
agreements. Since 2001, therefore, Chinese diplomacy has appeared to be less anti-
American,81 although Beijing continues to work toward a multipolar world less
dominated by the United States. It is apparent to Beijing that its national economic
and military power is still too small to exercise much direct leverage over the United
States and nations supportive of U.S. efforts. But China appears to be taking
advantage of its rising economic clout and growing trend toward regionalism to
attempt to develop some mechanism to check what it considers to be U.S.
hegemony.82 This could be some sort of Asian community or more formal
One observer concludes that regionalism in Asia is less a matter of formally
organizing separate nations into something akin to the European Union or NATO
than a matter of integrating countries on the fringes of China into a vast China
market.83 Because of the wide disparity in types of government, levels of economic
development, security orientation, and relations with the United States, the most
likely plurilateral institutions for Northeast Asia seem to be free-trade agreements
with China at the center and deeper currency and other financial arrangements
cooperation such as the Chiang Mai Initiative and Asian Bond Fund.
A test of the growing influence of China appeared in the plans to hold the first
East Asian Summit on December 14, 2005. One group of organizing countries led
by Malaysia (with sympathies from China) wanted to limit the membership to
ASEAN plus China, Japan, and South Korea (ASEAN + 3). Another group led by
Singapore, Indonesia, Vietnam (with sympathies from Japan) wanted to make the
gathering more inclusive — partly to dilute the influence of China. Ultimately, India,
Australia, and New Zealand were added to the attendee list. The United States was
not even accorded observer status. After the summit, China appears to be retreating
toward ASEAN + 3 as the East Asian structure most conducive to and consistent
with its regional goals in Asia. In either the East Asian Summit or ASEAN + 3,
China appears to be maneuvering to position itself at the center of any East Asian
economic and political arrangement that might become institutionalized while
nudging the United States to the periphery.84

81 Sutter, Robert G. China’s Rise in Asia - Promises, Prospects and Implications for the
United States. Asia-Pacific Center for Security Studies occasional paper, February 2005.

11 p.

82 Rozman, Gilbert. Democratization in Greater China: The Northeast Asian Regional
Context. Orbis, Spring 2004, p. 229-30.
83 Woo-Cumings, Meredith. Three Mirrors for Korea’s Future, in Confrontation and
Innovation on the Korean Peninsula, ed. by the Korea Economic Institute, 2003. P. 138.
84 CRS Report RS22346, East Asian Summit: Issues for Congress, by Bruce Vaughn. Wain,
Barry. Asia Wrangles Over Whom to Include in Forum. The Wall Street Journal, April 5,

2005. P. A15. Vatikiotis, Michael. East Asia Club Leaves U.S. Feeling Left Out.

International Herald Tribune Paris: April 6, 2005. pg. 8. East Asia Summit Expansion
Bid may fuel Friction. South China Morning Post, April 6, 2005. P. 4.

The growing influence of China is also being reflected in issues such as the
lifting of the European Union’s arms embargo on China. Japan has sided with the
United States in opposing the lifting of the embargo, but the apparent ease with
which Beijing garnered initial support in the European Union and the silence on the
issue from South Korea seems to reflect the allure and magnitude of the Chinese
market — in combination with other factors (such as European pique over the Iraq
War and their desire for a more multipolar world).
With containment of communism no longer an imperative and the probability
of a conventional military attack on homelands diminishing, attitudes in Japan and
South Korea toward U.S. forces also are changing. In both countries, public support
of the U.S. presence is still strong but weakening. The basic alliances are still solid,
but some are viewing the role of U.S. forces as less of a bulwark against outside
attack and more as a backup safety measure just in case some country opts to take a
hostile and disruptive action in the region.85
A serious problem exists in Northeast Asia that diminishes the ability of the
democratic states in the region to counter Beijing’s influence. The problem rests on
the basic trust of Japan. In South Korea, in particular, there exists such an overhang
of acrimony for Japan’s 50-year occupation that hardly any bilateral activity seems
to go well. Talks on a South Korea-Japan free trade agreement seem to be stalled
(ostensibly because of agricultural issues), and a dispute over possession of an island
has again flared up. In calls for Japan’s apologies, in interpreting history in Japanese
textbooks, and other such issues, Seoul sides squarely with Beijing. The United
States could work more with Japan and other countries in the region to resolve
historical issues and dampen popular forces of nationalism in order to keep those
nations from drifting toward an explosive enmity that could be avoided and could
threaten U.S. interests. From one perspective, as long as the nationalistic and
emotional outbreaks are kept under control, however, the United States actually could
benefit. In this view, the more the Asian nations squabble among themselves, the
more they tend to view the United States as a distant, third party whose history of
relatively non-imperialistic policies can be welcome.
International economic relations are like streets — they go both ways. While
Beijing has been trying to coopt its neighbors, particularly Taiwan, by enticing them
into the Chinese economic and trading network, Japan, South Korea, and Taiwan
have effectively coopted China by making it dependent on their technology,
financing, markets, and trade expertise. The net result of this mutual dependency is
that all parties now have much to lose by any crisis — be it military or financial —
that would disrupt economic and financial flows in the region. Economic activity
abhors instability. The “electronic herd”86 is likely to stampede at the first whiff of
a serious military clash in Asia. Stock markets would fall; bond ratings would suffer;
interest rates would rise; capital would flee; and a risk premium would be applied to

85 Kawashima, Yutaka. Japanese Foreign Policy at the Crossroads, Challenges and
Options for the Twenty-first Century, Washington, Brookings Institution Press, 2003. Pp.


86 See Friedman, Thomas L. The Lexus and the Olive Tree : Understanding Globalization
(Anchor Books, 2000).

investments in the region. All four governments, therefore, seek stability in
international relations. Without peace, it is difficult for economic engines to churn
out wealth, and even a rumor of war triggers penalties from international financial
markets. It should not be surprising, therefore, for South Korea and Japan to seek to
improve relations with North Korea or carefully constrain their responses to
incursions by Chinese naval ships into their exclusive economic zones. It also
implies that sanctions or saber rattling that disrupt growing economic relations are
not likely to be welcomed in the region.
In summary, protecting U.S. interests in security, prosperity, and value
preservation can be consistent with the economic rise of China. The key lies in
channeling the burgeoning Chinese economic clout into paths consistent with U.S.
goals in the region. In these efforts, the forces of globalization and economic
interdependency among the economies of northeast Asia appear to align roughly with
U.S. interests in stability, economic freedom, and the promotion of democracy in
China. These same forces, however, have created the resources to fund military
buildups and have created convenient targets for tension (e.g. anti-Japanese
demonstrations in China) often unrelated to political issues at hand. A key for U.S.
policy seems to be to pursue policies with a sufficient dose of realism to account for
the rising economic, political, and military power of China, while also maintaining
long-term idealistic goals of fostering more representative government in Beijing and
inducing countries to pursue peaceful relations, not only because of the U.S. military
deterrent, but out of their own self interests.