Lowy Institute
  • This week it was announced that US President Barack Obama will be the Chief Guest at India's Republic Day celebrations next year, marking the first time the honour has been bestowed upon a US president. What does this mean for US-India ties?
  • India has become the world's largest weapons importer.
  • The Brookings Institution has released a report on the opportunities and challenges for India in reinvigorating the South Asian Association for Regional Cooperation.
  • David Brewster argues that India's understanding of strategic autonomy must evolve to remain relevant.
  • How can India speed up its justice system?
  • Six years on from the 26/11 Mumbai bombings, officials say India is facing a heightened terrorist threat.
  • Can India and Pakistan go green?
  • Amy Kazmin argues that tracking down India's overseas black money will be harder than the Modi Government thinks.
  • New York style blogger The Sartorialist  recently visited India. Here's the first image he posted from the trip, taken in Mumbai: 

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Senior economic policy makers, economic analysts, academics and commentators have been concerned about the daunting challenge of structural and budget adjustment facing Australia due to the decline in mineral prices from the levels reached in the boom period of 2003-04 to 2011-12.

In Beyond the Boom, John Edwards estimates that the mining boom contributed 3% to GDP: 'Three per cent of real GDP is big, but as a change over eight years it is not that big'. This estimate of 3% is central to Edwards' strong dissent from the widespread belief that Australia is facing a formidable challenge. Because of Edwards' profile and appointments, including on the Board of the Reserve Bank of Australia (RBA), his assessment carries weight in the policy debate.

In a paper published by the Minerals Council, I argued that Edwards has greatly underestimated the economic benefits of the boom and, therefore, has vastly understated the adjustment challenge. Subsequently, in his post on The Interpreter, Edwards attempted to refute some of my arguments.

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The crux of the matter lies in the distinction between production and income. Edwards' focus is on the production side, on the 'contribution to GDP from the mining boom to 2011-12'.

Almost all other commentators and modellers look beyond GDP, to the real income of Australians. Essentially, over and above GDP, during the boom a large boost was given to the income (or purchasing power) of Australians. Now that mineral prices have fallen, this will not recur, and it presents an adjustment challenge.

Economists have two standard methods to estimate the boost to economic income delivered by a boom in export prices: 

  1. The Australian Bureau of Statistics (ABS) way, using the System of National Accounts. This method yields a benefit equal to 14% of the GDP of 2011-12.
  2. The modelling way, using quantitative representations of the economy: this yields a benefit equal to 13% of the GDP of the year 2012-13 (argued in recent RBA Research Paper authored by Peter Downes et al. Although I discussed the paper in my Minerals Council critique of Beyond the Boom, it is not mentioned in Edwards' response as it was published after Edwards' book).

The ABS's national accounts tell us that over the decade to 2011-12, production as measured by real GDP grew more slowly than did the real purchasing power of GDP, as measured by national income. There was a 14% gain in income over and above the boost to GDP itself. This difference is usually called the 'trading gain', because it measures the benefit of a rise in the international terms of trade.

Before proceeding, here is a clarification to reassure Edwards: everybody has reported the size of the benefit of the boom as a ratio, equal to the benefit (however conceived) divided by some understandable denominator. Everyone, including Edwards, uses the GDP (or GNP) of the end year (2011-12 or 2012-13) as the denominator. Nobody who has contributed to the debate thinks that the ABS has estimated that the boom caused a 14% rise in GDP. Everybody knows that, because it takes GDP as given, the ABS method attributes no boost to GDP on account of the boom.

The Downes et al paper does, however, estimate that the boom did indeed boost the GDP of 2012-13 by 6%. National income was boosted by 13%, with the extra 7% mainly due to the trading gain.

Edwards steadfastly refuses to accept the standard interpretation of the trading gain as showing the rise in income, over and above the rise in GDP. His ground is that, for the 'trading gain' to become actual rather than merely hypothetical, the income boost must be spent on additional imports.

This assertion suggests a failure to understand national accounting. Edwards does not seem to appreciate that the ABS can estimate the size of the gain in income without having to show what uses were made of the income gain. Income can be used for saving, as well as for spending. Savings rose dramatically. Edwards amply documented the rise in saving, but he did not seem to understand that it refutes his argument that the ABS's 14% trading gain in income was merely hypothetical until it manifested as imports.

Moreover, Edwards has misinterpreted the facts about imports: 'Households, anyway, do not seem to have responded gladly to flat import prices. They have not very vigorously increased their purchases of imports compared with earlier trends.' But import prices were not flat. Instead, due to the rise in the exchange rate, they fell greatly, relative to Australian prices generally. That is what a sharp rise in the exchange rates does.

As to quantities, imports volumes rose about 70% faster than GDP in the boom (and the composition of imports did not change much). The additional imports were financed out of the higher national income and were stimulated by the large fall in the real price of imports.

The Downes et al paper confirms that the mineral boom caused a large rise in import volumes. The methodology used, a fully specified model of the economy, is far superior to Edwards' method, which estimated 'counterfactual' import volumes by simply comparing the decade before 2002-03 with the decade following.

Before going further, it is necessary to state that Edwards and all other commentators must realise that some benefits of the boom will last beyond its end. These lasting advantages are not captured in the production or income numbers discussed so far. They consist in huge rise in the capital stock, and a significant increase in private wealth, both of which will ease the adjustment to lower terms of trade.

There is a revealing lapse in Edwards' use of national accounts nomenclature. Although Edwards repeatedly states that his 3% is the mining boom's contribution to GDP, strictly his is an estimate of the mining boom's contribution to GNP, not GDP.

He first calculates the contribution as 6% of the GDP of 2011-12, but then discounts that by half because of foreign shareholdings in mining. But this is how the national accounts go from GDP to GNP, by deducting from GDP what is owned by foreigners on account of their productive and financial services (net of what is owing in the other direction). Thus, the ABS estimate of the trading gain takes account of foreign ownership of GDP and therefore, contrary to what Edwards asserts, should not be further discounted for foreign ownership.

Finally, there is something contingent in the way Edwards arrived at his 6% boost to GDP or 3% boost to GNP. If the rise of the exchange rate had been less, his estimate would have been more. Consequently, regardless of the cause of the rise in the exchange rate — and most observers say the mineral boom was a major, if not the prime factor — Edwards' method understates the national gain.

This is because the rise in the exchange rate reduced his estimate of the benefits of the boom, but did not reduce the benefits to Australia as a whole. Edwards measured the AUD-denominated benefits that flowed to the Australian owners of mining shares to state governments as royalties and to the ATO as company tax payments from miners. The rise in the exchange rate reduced these AUD flows (regardless of the causes of the rise in the exchange rate). But the rise in the exchange rate did not reduce the national gain. It merely redistributed some of it away from the Australian owners of mining shares and towards other Australians, including those purchasing imports which were now much cheaper in AUD terms.

Edwards needs to understand that (to the first order of approximation) a rise or fall in the exchange rate redistributes income and wealth, rather than increases or decreases national income and wealth.

Unfortunately, in a table I misreported the dates for which I estimated the effect of the exchange rate on Edwards' calculation.

In conclusion,  Edwards seems to have had difficulty in applying the System of National Accounts to the issue, he confuses GDP, GNP and economic welfare and he does not understand the redistributive effect of a rise in the exchange rate. As a result, Edwards greatly understates both the benefit of the boom and the burden of adjustment caused by the fall in the international terms of trade.

 The lone dissenter is sometimes right, but not in this case.

Photo courtesy of Flickr user Robyn Jay.

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As regular Interpreter readers have no doubt heard by now, the Chancellor of Germany, Angela Merkel, gave the 2014 Lowy Lecture last week in Sydney.

Sam Roggeveen has already outlined the main elements of what Merkel said, but the rest of world now seems to be catching on. That speech, and her words particularly on the crisis in Ukraine and Russia, are now being called a 'major shift in European geopolitics.' Indeed, Der Spiegel ran an editorial this week saying 'It was a clear challenge and turning point after a year of diplomatic efforts that, while not useless, now appear to have been exhausted.'

It has taken Chancellor Merkel some time to speak publicly about what she says are the 'forces which refuse to accept the concept of mutual respect' and who 'believe in the supposed law of the strong and disregard the strength of law.' President Obama argued something very similar in a speech at the UN General Assembly in September, where he said that Russia's aggression was 'a vision of the world in which might makes right — a world in which one nation's borders can be redrawn by another.' Aside from the significance of the leader of Germany (and to a large degree, Europe) coming around to speaking forcefully about Putin and Russian violation of international law, what is interesting about Merkel's speech is that it was given by Merkel herself.

A recent and lengthy New Yorker profile  by George Packer paints a picture of someone who is coolly detached from her ego and who did not come to politics naturally. She is a triple threat in German politics: 

Among German leaders, Merkel is a triple anomaly: a woman (divorced, remarried, no children), a scientist (quantum chemistry), and an Ossi (a product of East Germany). These qualities, though making her an outsider in German politics, also helped to propel her extraordinary rise. Yet some observers, attempting to explain her success, look everywhere but to Merkel herself. “There are some who say what should not be can’t really exist—that a woman from East Germany, who doesn’t have the typical qualities a politician should have, shouldn’t be in this position,” Göring-Eckardt, another woman from East Germany, said. “They don’t want to say she’s just a very good politician.” Throughout her career, Merkel has made older and more powerful politicians, almost all of them men, pay a high price for underestimating her.

And on her analytical qualities: 

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People who have followed her career point to Merkel’s scientific habit of mind as a key to her political success. “She is about the best analyst of any given situation that I could imagine,” a senior official in her government said. “She looks at various vectors, extrapolates, and says, ‘This is where I think it’s going.’ ” Trained to see the invisible world in terms of particles and waves, Merkel learned to approach problems methodically, drawing comparisons, running scenarios, weighing risks, anticipating reactions, and then, even after making a decision, letting it sit for a while before acting. She once told a story from her childhood of standing on a diving board for the full hour of a swimming lesson until, at the bell, she finally jumped.

Packer puts particular emphasis on Merkel's political maneuvering and her ability to play a long game. Speaking about the Chancellor and one of her long-time and trusted political advisers, Beate Baumann: 

Fed up with Kohl’s smug bullying, the two women practiced a form of “invisible cruelty”: they played hardball but relished their victories privately, without celebrating in public and making unnecessary enemies. Their style, Ulrich said, is “not ‘House of Cards.’ ” On one rare occasion, Merkel bared her teeth. In 1996, during negotiations over a nuclear-waste law, Gerhard Schröder, two years away from becoming Chancellor, called her performance as environment minister “pitiful.” In her interview with Herlinde Koelbl that year, Merkel said, “I will put him in the corner, just like he did with me. I still need time, but one day the time will come for this, and I am already looking forward.” It took nine years for her to make good on the promise.

Early on in the Ukraine crisis, Merkel, who speaks fluent Russian, was said to be the closest to Putin and the Western leader who knew him best. A last extract for those that doubt her resolve:

John Kornblum, a former U.S. Ambassador to Germany, who still lives in Berlin, said, “If you cross her, you end up dead. There’s nothing cushy about her. There’s a whole list of alpha males who thought they would get her out of the way, and they’re all now in other walks of life.”

The piece is also littered with great anecdotes about a leader who rarely gives personal interviews: 

In off-the-record conversations with German journalists, she replays entire conversations with other world leaders, performing wicked imitations. Among her favorite targets have been Kohl, Putin, King Abdullah of Saudi Arabia, former Pope Benedict XVI, and Al Gore. (“Ah have to teach mah people,” she mimics, in a Prussian approximation of central Tennessee.) After one meeting with Nicolas Sarkozy, the French President, during the euro crisis, she told a group of journalists that Sarkozy’s foot had been nervously jiggling the entire time.

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By Anna Kirk, an intern in the Lowy Institute's Melanesia program.

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Within hours of US Secretary of Defense Chuck Hagel announcing his resignation, candidates to replace him were being named. Within a day, two out of the top three rumoured candidates removed themselves from contention. So the quest to find a new Secretary of Defense is becoming a case of 'who's left?' Given the challenges abroad, and more importantly at home, this is understandable.

Tom Switzer pointed briefly to the 'gruelling confirmation hearings' that await a Secretary of Defense nominee before the now Republican-controlled US Senate. The reputation for intense scrutiny experienced during these sessions has already forced high profile Obama Administration candidates to reconsider.

But to say the domestic concerns of a new Secretary of Defense end there would be incorrect. Consider for a moment the unenviable position of managing the world's most powerful military amid budgetary uncertainty and while conducting a military campaign in the Middle East.

But perhaps the greatest domestic challenge confronting a new Secretary of Defense is his or her place within the Obama Administration. The resignation of Chuck Hagel has led some informed commentators to believe he was a victim to what is seen as the White House's increasing centralisation of national security decision-making. Tom Ricks of Foreign Policy wrote:

Unless you have total White House backing in the first place, the job is almost impossible. Without such a commitment, it is just a nightmare.

Obama's eventual nominee will reflect a desire to either increase or decrease this trend of centralisation. Obama can pick a Secretary of Defense either because he/she will advocate and execute White House policy, or because he/she can be trusted to work in relative autonomy. These qualities are not mutually exclusive, but they won't always synchronize. The President's eventual choice will reflect his preferences and determine the direction of US National Security policy for the foreseeable future.

Photo courtesy of Flickr user US Department of Defense.

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Last week's Fifth Xiangshan Forum in Beijing demonstrated just how difficult it will be to resolve disputes in the South China Sea as long as key parties believe history must arbitrate the veracity of claims to sovereignty over contested islands.

Scholars, officials and military officers from all around Asia were present, including many from the claimant countries in territorial disputes in the South China Sea, such as Vietnam and the Philippines. 

One of the strongest messages at the forum was how intensely most regional actors feel that there is a problem of deep strategic mistrust, and how important genuine communication and dialogue is in overcoming that mistrust. Yet these same actors were all firmly committed to their own positions and seemed to show little interest in accommodating the views of others. This is not particularly surprising at an event like this, but it does not bode well for achieving lasting peace and security.

Several of the presentations from ASEAN countries made repeated references to the importance of resolving disputes in the region multilaterally, rather than focusing on bilateral negotiations. This was understood by forum-ologists as a thinly veiled criticism of China's approach to the ASEAN region.

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The Philippines' Major General Raul Del Rosario was more direct. The Philippines currently has a case against China with UNCLOS over parts of the South China Sea, including the Scarborough Shoals — small islands in what the Philippines calls the West Philippines Sea. In his speech, the Major General thanked China for its assistance after Typhoon Haiyan and emphasised that maritime disputes were only a small part of Sino-Philippines relations. He then laid out his view that creating a regional environment based on trust was becoming increasingly difficult, when, as he put it, some actors promote their own narrative and expect others to change their outlook accordingly. He criticised unnamed states for being inflexible, subjectively interpreting facts and ignoring the rule of law.

Should the audience have been in any doubt as to what he was referring to, the Major General then explicitly spoke about the Philippines' commitment to resolving disputes with China in the South China Sea based on the UNCLOS rules-based approach, and behaving according to what he described as universal principles and norms. 

The speech may have been counter-productive for the Philippines. One of China's narratives is that the US has historically attempted to prevent it from resuming its rightful role in world, and that it will continue to do so. This view is powerfully resonant among the Chinese people. By promoting UNCLOS and universal norms, the Philippines is likely be seen in China as aligning itself with the US, meaning its views can be dismissed. Arguably, the Philippines would be better off pursuing its objectives by speaking with the same voice as ASEAN.

The Major General's views were certainly in line with that of the US speaker. Earlier in the same panel, US Admiral (Ret) Gary Roughead, Former Chief of Naval Operations, set out the non-official US position. As with the official US position, Roughead emphasised freedom of navigation, that the US 'rebalancing' to Asia was not a return as it had in fact never left and that all claimants in the South China Sea should clarify their claims consistent with international law. But Roughead went beyond the official US line in that he specifically raised concerns over what he described as a lack of clarity around the 'nine-dash line' that China argues delineates its territory in the South China Sea. 

The Chinese speakers, regardless of affiliation, emphasised the importance of Asian solutions. Referring to President Xi's vision for an Asia security concept outlined this year, General Chang Wanquan from the Ministry of National Defence made three suggestions for long-term stability and security in the region. Firstly, he recommended strengthening dispute-management procedures to deal with crises, which he explained as negotiating with respect to historical facts and timely information sharing. His second point was to strengthen defence cooperation to build strategic trust, and thirdly, he called for further strengthening of regional security architecture to foster a stronger sense of belonging to a community of common destiny and move past Cold War thinking. These points were generally well received.

General Chang painted a picture of China as alone in a largely hostile world, not yet fully recovered from its recent history, and still vulnerable to threats to its national interests. He put forward an image of China committed to being at the forefront of Asia's 'community of shared destiny' as a means for securing the region's stability. The image of China 'recovering' from history was shared by the other Chinese forum participants, and forms the basis of China's position on its territorial disputes in the South China Sea. 

Chinese media coverage of the Xiangshan Forum reflected General Chan's understanding. State media outlets such as the People's Daily portrayed China's role in the forum as a benevolent regional actor working tirelessly to ensure peace and stability. These reports focused on how China is collaborating with numerous countries in the region, such as India, Vietnam, the US and Kyrgyzstan, while other states such as Japan and the Philippines are undermining China's efforts to build security. Non-state outlets such as the South China Morning Post look more at how China is seen as a threat by countries in the region.

More than once during the Forum, Europe was used as an example of how mistrustful states could create and maintain a long-lasting peace. However, European cooperation required states to take the facts of the day as the foundation for the future, with some reference to history. In Asia however, powerful actors like China insist that history should be the foundation for cooperation, with some reference to current facts. Given that most if not all historical facts can be countered by an earlier fact, who has the right to decide at what point 'reality' should be established? 

For Chinese officials and everyday people alike, the narrative of national humiliation at the hands of foreign powers is an absolutely fundamental aspect of Chinese identity, and the only reality on which legitimate claims to territory in the South China Sea can be based. 

As such it is almost inconceivable that the Chinese Government could concede territory in the South China Sea without suffering a strong domestic backlash. Yet it seems that some compromise will be necessary for genuine cooperation and dialogue in the region. Policy-makers hoping to influence China's behaviour in the South China Sea need to understand just how critical the politics of history is to Chinese national identity and not presume that Chinese leaders will be either willing or able to back away from their understanding of historical facts.

Photo courtesy of Xiangshan Forum 2014 Website.

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The Indo-Pacific is a strategic system encompassing the Indian and Pacific oceans, reflecting the expanding interests and reach of China and India as well as the enduring role of the US. The Lowy Institute's International Security program presents a weekly selection of links illuminating the changing security picture in this increasingly connected super-region.

 The Lowy Institute International Security Program's work on Indo-Pacific security is supported by two grants from the John D and Catherine T MacArthur Foundation.

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'You can always count on China to be good to its neighbours this time of year', observes Carl Thayer. 'The money is meant to send a message that China is the big sugar daddy of Southeast Asia and will outbid the US.'

The APEC Summit in Beijing witnessed the hosts committing US$40 billion for the Silk Road and the same amount for ASEAN infrastructure

That China is providing development funds to formerly wealthier countries is itself remarkable. But the recent munificence highlights the deeper paradox: is China still a developing country or is it advanced? The answer, of course, is both. China identifies rhetorically with the South, even while it sends rockets to the moon. Such a large country with such awesome social disparities can simultaneously be developing and advanced. Its inequality does not hamper China's ability to export capital to richer countries; perversely, it enables it.

The reason is 'financial repression': legitimised diversion or confiscation of private wealth. Many countries employ this tool. China's repression follows the standard Asian formula of a controlled capital account, low deposit rates and (until recently) an undervalued currency. 

With the breaking of the 'iron rice bowl', households were suddenly forced into precautionary savings for their old age. The result is an 'imbalanced' economy in which households save an unhealthy fraction of what they earn while government banks skim off these savings to gorge themselves, indulge SOEs and distribute largesse to other countries. The central bank also sequesters foreign exchange earnings as official reserves through exchange rate intervention, and the Government represses consumption with regressive taxes.

All of these measures shift value from savers and consumers to borrowers and producers. Some estimate the annual transfer at 5-8% of GDP. As a result, Beijing's fiscal condition looks robust (though the IMF disagrees), with the Government flush with cash while Washington DC has shutdowns.

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Naturally, Chinese state funds deployed abroad come with an agenda. Beijing expects that over time, other countries will recognise that 'China is the giver of economic benefits, US staying power is questionable and they (must) accommodate Chinese interests', says Bonnie Glaser at CSIS. She continues, 'China's strategy is to weave together a network of economic interdependence. It is using the centrality of its power to persuade (them) that to challenge China...is simply not worth it.' And Chinese officials readily admit a main objective of its various development funds is to find outlets for surplus capacity. China's steel industry already exports 80 million tonnes, equivalent to India's total output.

This is in contrast to America's TPP. Min Ye makes some comparisons:

 The TPP seeks to reduce the roles of governments in market operations and to restrict the importance of SOEs, Beijing's Silk Road plan relies on top-level government coordination and enhances the power of large state owned enterprises. TPP focuses on services, IPR and domestic regulations. The Silk Road strategy aims to facilitate large-scale infrastructure construction, energy sale and transport, and relocation of manufacturing industries.

Vladimir Yakunin, head of Russian Railways, has learned of Beijing's limitations and conditions. 'Russia has so far had little success in tapping Chinese funding for its corporate sector', writes the Financial Times, and the few deals 'were all tied to purchases of Chinese equipment.'

By contrast, commercial financing on market terms from private sources is America's forte. While Washington can punish Wall Street, it can hardly tell bankers where to lend or invest. Americans invest US$350 billion overseas annually yet, sanctions aside, a US president cannot significantly influence where in the world they invest.  Xi Jinping, on the other hand 'dangles' US$1.25 trillion of outbound investment over the next decade, plus 500 million Chinese tourists. So Beijing certainly can direct state companies, though neither it nor Washington can commit the future agency of private actors. 

It's also important to keep scale in perspective. China's official foreign exchange reserves are US$4 trillion; a single US company manages more. Global equity funds total over US$20 trillion and debt markets are bigger still. Beijing is extremely powerful, but its clout partly derives from its willingness to undertake financial risks that other states, and a much larger private sector, rejects.

The payoff of China's 'financial repression' strategy is uncertain in the long run, but today it buys geopolitical influence and explains Beijing's enthusiasm for establishing new multilateral lending agencies under its own aegis (it also has two very large export/development banks of its own). To be sure, there is much investment needed globally in infrastructure, not least in America. Governments inevitably must play a role in infrastructure building, and China should pursue quality opportunities abroad. If eventually, however, the financial returns on China's overseas development projects are poor, we might not ever hear the news. But we will see the consequences of misallocation and misadventure: high indebtedness, low returns for savers and pensioners, and ultimately lower living standards for Chinese citizens, who will foot the bill for Beijing's moneybags foreign policy.

Photo courtesy of Flickr user Jim Fischer.

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UPDATE: Here's an interview with China's chief climate negotiator on the US-China deal.

In case there is any residual euphoria left over the China-US climate agreement, here are a couple of pieces to put a dampener on it. First, here's Alex Evans, a Senior Fellow at the Center on International Cooperation (CIC) at New York University, writing at Global Dashboard:

The policies and measures unveiled in yesterday’s US-China announcement are awfully thin. There’s a “renewed commitment” to technology cooperation, with no funding numbers attached. Some stuff about a demonstration project on carbon capture and sequestration, which people have been talking about for over a decade now – it’s starting to sound like nuclear fusion. More cooperation on reducing HFC emissions, which do have massive global warming potential, but are incredibly easy for China to reduce – cynics like me think that China was actively inflating them so as to score Clean Development Mechanism permits, and is only now talking about a phase out because demand for CDM permits has collapsed along with EUETS prices. There’s a “climate smart low carbon cities initiative” which is basically a plan to convene a summit. And that’s pretty much it.

This was an eye-opener:

I was talking last night to a veteran climate negotiator from a developed country government, who observed that the climate priesthood has, for years, been having far too nice a time meeting up every six months for drinks and per diems. No one wants the party to end. There is no sense of urgency. No real deadline. She’s absolutely, 100% right. I started going to UN climate summits when I was a student. Next summer I’m 40. And the conversations in Warsaw last winter had basically not moved on since the first one I went to in the Hague a decade a half ago. The only way this will ever end, she continued, is if policymakers give them six months to work out a solution, and make clear at the outset that at the end of this period, they can all piss off home.

The second article is by two engineers at Google who worked together on the company's now abandoned renewable energy initiative called RE<C. They discovered that even if this plan had succeeded, it would not be enough:

Suppose for a moment that (RE<C) had achieved the most extraordinary success possible, and that we had found cheap renewable energy technologies that could gradually replace all the world’s coal plants—a situation roughly equivalent to the energy innovation study’s best-case scenario. Even if that dream had come to pass, it still wouldn’t have solved climate change. This realization was frankly shocking: Not only had RE<C failed to reach its goal of creating energy cheaper than coal, but that goal had not been ambitious enough to reverse climate change. That realization prompted us to reconsider the economics of energy. What’s needed, we concluded, are reliable zero-carbon energy sources so cheap that the operators of power plants and industrial facilities alike have an economic rationale for switching over soon—say, within the next 40 years.

The piece seems unduly pessimistic to me, given that it barely mentions the effect carbon pricing would have on the economics of renewables.

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Malcolm Cook and I have been debating why China has been willing to bless Tony Abbott with an FTA when Mr Abbott has so strongly opposed Beijing's political and strategic interests and aspirations in Asia.

Why has President Xi met Mr Abbott's stick with such a juicy carrot, especially when Beijing has been so quick to use the stick itself on other neighbours? (Sam raised the related and important question of why China uses the stick at all when it has so many carrots to offer, to which I have offered an answer separately.)

Malcolm's explanation is that the economic benefits to China of the FTA simply outweigh the costs to China of Australia's position on strategic questions. He does not dispute that those strategic costs are significant, because he concedes both that China is serious about creating a new order in Asia, and that Australia's attitude to this is important to Beijing. He just thinks the economic advantages to China of a FTA with Australia are big enough to counterbalance them.

I'm not so sure. I think it is more likely that Xi and his colleagues believe that wider economic opportunities and kind words will seduce Australia away from its alignment with China's strategic rivals, and encourage us to be more willing to accommodate China's ambitions for regional leadership.

Of course it may be that we are both right to some degree. But it remains important to judge the relative weight of each factor in China's approach to Australia, because the implications for our position in Asia and our future policy depend a lot on which of them predominates.

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Malcolm's argument that economic factors predominate in Beijing's decision rests on judgments about the scale of the perceived economic benefits of the new FTA to China. That is hard to judge at this stage, of course, but we need to be careful not to take last week's euphoria at face value.

The evidence suggests that FTAs actually make very little difference to trade flows or GDP growth. Our Government's only word on this is a 2005 DFAT-sponsored study, which was the source of the much-cited figure of US$18 billion boost to Australia's GDP from an FTA with China. Here is what that study said about the impact, had there been an FTA between Australia and China over the past decade:  

In terms of average annual growth rates between 2005 and 2015, the FTA is estimated to increase Australia's real-GDP growth by 0.039 percentage points; and increase China's real-GDP growth by 0.042 percentage points.

Yes, that's right – four hundredths of a percentage point. In other words, the impact on GDP for China, as for Australia, was estimated to be utterly negligible, and there is no reason to believe that the deal that has now been done will have a significantly greater effect. Indeed the Productivity Commission's 2010 report on FTAs strongly suggests that it won't. It concludes that FTAs in general do nothing at all to boost trade or growth.  

But are there other economic benefits? One view is that China values an FTA with Australia to drive reform within China, which might indirectly boost growth. One cannot dismiss this out of hand, but it does seem on the face of it very improbable. The CCP seems to have no trouble driving reform on its own, and if it needs help from outside, why Australia? China has already signed FTAs with many advanced and prosperous countries which pose it no strategic problems. How does adding Australia to the list help?

So from the available evidence there doesn't seem much reason to think that economic motives have been uppermost in Beijing's decision to cuddle up to Tony Abbott. The fact is that this FTA, like others, is much more about politics than economics, in Beijing as well as in Canberra.

And one cannot help but notice that Beijing seems to have secured precisely the political outcome I think they were aiming at. Tony Abbott did, at least while Xi was here, show himself much more open to China's vision of Asia's future than he has ever been before, and he did so in direct defiance of Barack Obama's very plain and stern warnings just two days before Xi spoke in Canberra.

Time will tell whether this proves to be anything more than a passing blip. Tony Abbott may well revert to his previous strategic alignment against China at the next opportunity. If so, it will be instructive to see how China responds. That would perhaps tell us more about its motives and purposes.

In the meantime, it is easy to understand the attractions of Malcolm's interpretation of events. It would be nice to think that Australia's economic weight and sophistication is such an irresistible magnet for China that we can dictate the terms of the relationship and compel it to accept without demur whatever strategic positions we choose to adopt.

Be we would be unwise to assume that this is what is happening. It is at least as likely that the boot is on the other foot, and that China's economy is so important to Australia's future that Beijing can set the terms of the relationship — either by carrot or stick or both — and persuade us to look more kindly on China's aspirations for regional leadership.

Photo courtesy of the Department of Foreign Affairs and Trade.

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  • China to scrap its 2700 year-old state monopoly on the sale of salt.
  • Jin Zhirui of China's Air Force Headquarters explains China’s recent island construction in the South China Sea: 'There is a need for a base to support our radar system and intelligence-gathering activities'. 
  • Meanwhile, Bonnie Glaser says the island construction is in preparation for an ADIZ in the South China Sea.
  • To meet its new commitment to cap carbon emissions by 2030 and turn to renewable sources for 20% of its energy, Bloomberg reports China needs to produce either '67 times more nuclear energy than the country is forecast to have at the end of 2014, 30 times more solar or nine times more wind power' (or, I guess, some combination of these).
  • The State Council unveiled its 2020 energy action plan, which includes raising renewables to 15% of China's total energy mix.
  • China flexes its muscles at APEC with the revival of Free Trade Area of the Asia Pacific.
  • SCMP reports there is a split within Hong Kong's pro-democracy movement.
  • Carl Mizner explores what last month's fourth plenum means for the direction of law in China.
  • The inability of local governments to clean up Lake Tai, despite pledging US$14 billion to tackle the problem, highlights the magnitude of China's pollution challenges.
  • This musical ode to Xi Jinping and his wife has gone viral:

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In late October, the US and South Korea agreed to delay the issue of who would control the Republic of Korea Army (ROKA) in the event of a war on the Korean Peninsula. In the argot of Korean security, this is known as the reversion of operational control or 'OPCON'. The debate on this issue has raged for a decade. It now appears over; indefinite extensions mean it is probably no longer a meaningful option.

Since the war in the 1950s, the US had maintained control over the entire South Korean military. US Forces Korea (USFK) were integrated with ROK forces into a Combined Forces Command, which was in turned integrated into the United Nations Command. All three commands are headed by the same person – a four-star US general. The current commander is Curtis Scaparotti.

This command structure is unique. Nowhere else does a US commander operate under multiple jurisdictions like this – not in Japan or NATO. (A nice review here.)

Unfortunately, this structure also implicated the US military in Korea's earlier dictatorships. When leftist critics of the US position in Korea argue that the US 'runs' Korean foreign policy or that Washington is responsible for past Korean dictatorial repressions (most notably in Kwangju), this is usually what they mean. US defenders have argued that if dictators like Park Chung-Hee or Chun Doo-Hwan had exercised full control of the South Korean military, the repressions would have been much worse.

Thankfully, as the ROK matured into a democracy, it was increasingly capable of governing its internal affairs without recourse to authoritarianism. In this environment, peacetime OPCON was reverted in 1994. As hostilities with North Korea have not recommenced since then, this means the South Korean civilian government effectively exercises full-time independent control over the military. Coupled with an independent defence budget (that often focuses on flashy weapons systems USFK would not recommend) and the civilian leadership of the Ministry of National Defence, South Korea acts increasingly on its own in defence matters.

At the same time, US military personnel totals in Korea have steadily shrunk from a wartime high of nearly 1 million to the current 28,500. In short, the bulk of the defence burden in South Korea and the policy choices behind it increasingly fall on Seoul. This is progress, insofar as the division of the Korean peninsula is a Korean affair.

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In the early 2000s, the remaining joint structure came under criticism from the Korean left. In 1998, Korea's first liberal president, Kim Dae Jung, took office. Kim is most famous for launching the Sunshine Policy. Although Korean voters eventually turned on it as a failure, in the late 1990s and early 2000s the Sunshine Policy was widely seen as a breakthrough. Kim won the 2000 Nobel Peace Prize, and his successor, also a liberal, Roh Moo-hyun, continued the policy. He also ran an aggressively anti-American political campaign in 2002. 

In this environment, CFC and US OPCON of the wartime South Korean military was understood as an unnecessary provocation of North Korea and an infringement of South Korean sovereignty. A long-standing goal of North Korea has been the reduction, if not complete withdrawal, of USFK. A staple Northern claim is that USFK divides the peninsula and makes South Korea a 'Yankee Colony.' As I have argued elsewhere, while this may seem propagandistic to Western observers, it is surprisingly resonant in South Korea. Anti-Americanism in South Korea is entrenched, particularly in parties of the left and in the film industry. It tends to come in waves, most recently in the beef protests of 2008, and Korean liberal politicians such as Roh routinely exploit it.

Roh sought a final 'peace regime' with the North (the two Koreas are still legally at war; the current peace is actually a 61-year armistice). One informal concession was to be the elimination of CFC and a scaling back of USFK's role in South Korean security. Military OPCON reversion served a domestic purpose too; it buttressed the claim of Roh, and the left generally, that South Korea was independent of the Americans, and played to traditional Korean prejudices that Korea has been manipulated by covetous foreigners (the Chinese, Mongols, Japanese, Americans). An old Korean aphorism goes that 'Korea is a shrimp among whales.' All Koreans, North and South, could agree that the Yankees were obstructing Korean reconciliation.

At the high point of the Sunshine Policy, when North and South Korea seemed closer than at any time since the war, directing Korean nationalism toward the Americans as blocking better relations was a masterstroke. In 2006, Seoul and Washington agreed to OPCON reversion by 2012.

The history since then is a curious case of unintended consequences that ended in the current arrangement, which delays OPCON until 2020 at the earliest. Almost immediately Seoul had buyer's remorse, while the Americans were increasingly happy to be rid of the burden. Donald Rumsfeld, US Secretary of Defense at the time, disliked Roh intensely and actually welcomed the greater US flexibility OPCON reversion would permit. In the mid-2000s, the US security establishment was pre-occupied with the War on Terror; officials, including Rumsfeld himself, started speaking of it as a 'long war.' If the US was going to be fighting terrorism for decades in failed states in the greater Middle East, wasn't it time for mature, wealthy democracies like South Korea to carry their own weight?

On the Korea side, the burden of OPCON also hit home. As USFK shrank, CFC came into question, and with the US focused increasingly on Islamic terrorism, South Korea would need to spend more on defence (a lot more actually) and significantly improve the professionalism of both its conscript force and officer corps. For a military long accustomed to (or perhaps coddled by) the US guarantee, this was a major challenge, and OPCON reversion has been repeatedly delayed because the South Koreans simply are not ready.

South Korean conservatives turned against the deal almost immediately, calling for OPCON delays. As the Sunshine Policy ran aground on persistent North Korean intransigence, South Korean voters turned against it by electing the very hawkish, pro-American Lee Myung Bak. Lee, like the electorate, had come by the mid-2000s to the conclusion that North Korea was not actually changing under the Sunshine Policy but was simply milking it as a permanent subsidy. North Korea responded in 2010 by sinking a South Korean destroyer and shelling an island, killing 50 people.

Since then, OPCON reversion has been delayed repeatedly, taking us to the current arrangement. It seems safe to say at this point that the ten-year soap-opera of OPCON reversion is over. A delay to the 2020s is effectively indefinite, which in turn means it almost certainly will not happen. CFC/USFK is pretty much permanent now.

Photo courtesy of Flicker user US Pacific Command.

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Tom Allard recently reported in the Sydney Morning Herald that Australia and East Timor are ready to restart talks on the maritime boundary between the two countries, with all its complications of petroleum revenues and history. The tradition is to keep these talks under wraps, but Allard's article puts the topic back on the public stage. 

The Timor Sea and maritime arrangements between Australia and Timor Leste. (DFAT.)

If this issue were to be decided on the basis of 'they are poor and we are rich', then the facts are irrelevant, except perhaps for this fact: thanks to the existing treaty arrangements, Timor has a petroleum fund currently holding US$16.6 billion, unable to be effectively spent as fast as the revenue is flowing in

If poverty is not the criterion, then geography is. The original 1972 maritime boundary with Indonesia (West Timor and the parts of Indonesia to the east of East Timor) was drawn much closer to Indonesia than the mid-point between the two countries (see map above). This might seem unfair until you look at a cross-section map of the seabed or a map showing sea-depth (see map below), on which Australia's continental shelf is clear, as is the Timor Trench dividing the two land-masses.

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The treaty history is summarised here. Portugal was still in control of East Timor at the time of the 1972 treaty, and it didn't want to participate in defining the border, hence the 'Timor Gap'. After Indonesia took over East Timor in 1975, this gap was addressed in a treaty which left the border to be determined later, but created the Joint Petroleum Development Area (JPDA; see first map) so that, in the meantime, the just-discovered petroleum resources could be developed.

After East Timor's independence from Indonesia, these delineations were retained in the new treaties, but a much more favourable division of the petroleum revenues was agreed. The Sunrise gas field (the richest undeveloped field, with estimates putting its gross value at $40 billion) lies mostly outside the JPDA, with about 20% in the Area and 80% in Australia's territory. The initial treaty with Indonesia had split the revenue within the JPDA 50:50, with Indonesia getting no share of gas field revenues outside of it. After the renegotiations, the newly independent East Timor received 90% of the JPDA revenue and 50% of the upstream revenues from the Australian part of Sunrise.

Sunrise gas field (Hydrocarbons Technology Market & Customer Insight)

A key element of all the treaties was to delay any consideration of the final border delineation of the Timor Gap for 50 years. If no development agreement was reached for the JPDA during the six years after the 2006 treaty was signed, either party could terminate it, but so far the treaty remains in force. Terminating it would open up the possibility of looking at the border again. But it would also affect the status of the revenues which both parties get from current production and might halt further investment. 

What would happen in a renegotiation? Allard asserts: 'A boundary equidistant between the two countries — as is the norm under international law — would result in most of the oil and gas reserves, worth more than $40 billion, lying within East Timor's territory.'

Yes, if the border were drawn equidistant, this would put the JPDA resources in Timor's territory, but Dili already gets 90% of these revenues. and it's true that UNCLOS decisions have favoured equidistant borders because continental shelf features are often unclear and subject to huge dispute.But in this case the shelf and the trench are indisputable geographic features. That said, Australia is not ready to have this tested and in 2002 declared that it would not submit itself to international dispute resolution mechanisms relating to 'sea boundary delimitations as well as those involving historic bays or titles.'

Even if East Timor were to succeed in renegotiating the border to mid-way (which, to give some idea how this would look, is the south-eastern edge of the JPDA shown on the first map), this still wouldn't put the rich prize of Sunrise in Timor's territory. Most of Sunrise is clearly to the east of the nearly north-south line demarking the eastern edge of the JPDA. This border is not in dispute and it is drawn in accordance with the conventional rules based on the geography of East Timor and Indonesia.

Going one step further, if East Timor succeeded in getting an equidistant border, Indonesia would surely want to do the same thing and could find an excuse. This would put the largest part of Sunrise in Indonesian territory. East Timor might then see if Indonesia was ready to share the revenues 50:50 with it.

Australia's negotiating history on this subject is not a glorious one. Why, for instance, was it worth the risk of getting caught spying on East Timorese negotiators when, as the Foreign Minister of the time said, 'you didn't have to spy on the East Timorese to find out what their position was'. Defending the current arrangements shouldn't be too hard, either on legal or moral grounds. Let's hope we make a better fist of it this time.

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The conduct of the general elections in Solomon Islands on 19 November appears to have been largely successful. An interim report from the Commonwealth Observer Team led by former Prime Minister of PNG Mekere Morauta has praised the conduct of the Solomon Islands Electoral Commission, the Royal Solomon Islands Police Force (RSIPF), and the public for the conduct of the poll.

Solomon Islands House of Parliament

However, good electoral process will not necessarily equate to the formation of a good government and a functional and stable parliament. Nor will it eliminate violence and civil unrest.

The introduction of a biometric voter registration system for this election has greatly reduced electoral fraud and duplicate enrolments. The electoral roll has been reduced by over 160,000 names since the 2010 election. Although there were some that missed out on enrolment, such as 3000 students studying overseas, the new system should enhance the legitimacy of the results. Despite the logistical hurdles faced by the Electoral Commission, extensive voter education was carried out and 867 polling stations operated across the country.

Preliminary estimates indicate an enviably high voter turnout of around 85%.

The biggest upset occurred when sitting Prime Minister Gordon Darcy Lilo lost his seat to his nephew and former campaign manager Jimson Fiau Tanagada. Despite some controversy over 300 voters being unable to cast their votes due to boat delays, and some calls for a recount from supporters of losing candidates, Lilo has accepted his defeat with good grace.

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Otherwise, the poor representation of women is still an issue. Out of 26 female candidates, only one was elected to the 50-seat parliament; businesswoman Freda Soria Comua unseated Foreign Minister Clay Forau in Temotu Vatud by just 22 votes. The only female MP in the last parliament, Vika Lusibaea, was not re-elected. Unfortunately this low representation is not unusual across the region, but it is far behind Fiji, which elected seven women MPs in its September election.

The poll was carried out without major violence or incident, except for a failed attempt by an electoral official to steal a ballot box in Auki, Malaita. It is worth noting that election days have generally been held without major incident in the Solomon Islands. The more unpredictable period will be the horse-trading over the next few weeks that will determine the appointment of the prime minister and cabinet.

Historically around 50% of Solomon Islands MPs have held on to their seats for one election before being thrown out by voters. This election has bucked the trend, with 35 MPs being re-elected. Solomon Islands expert Dr Tarcisius Tara Kabutalaka attributes this more to the late release of large amounts of discretionary funds to MPs to influence voters rather than satisfaction with their performance. Some of the new MPs should bring some much needed renewal into parliament, such as former University of the South Pacific Lecturer Dr Culwick Togamana. However, the return of so many incumbents will likely entrench dysfunctional government and prevent reform. 

Journalist and candidate Alfred Sasako alleged that 26 MPs were under investigation by police. This could be an exaggeration, but there is no doubt that there are major corruption problems within parliament. MPs in Solomon Islands, as in other parts of Melanesia, are elected on their ability to deliver direct benefits to their constituents rather than their ability to govern the country. Included in the new parliament are convicted criminals Jimmy 'Rasta' Lusibaea and Manasseh Maelanga. The number of MPs with questionable pasts does not augur well for parliament tackling corruption and serious reform.

Competition over who is elected prime minister will be hotly contested this year.

Solomon Islands has always had weak political parties but despite the introduction of laws to strengthen them earlier this year, more than half of the parliamentary MPs have been elected as independents. The lack of party affiliation and the presence of a number of high profile individuals who might have a tilt at leadership, including four former prime ministers, makes the outcome of the next few weeks of horse trading difficult to predict.

The elimination of outgoing prime minister Gordon Darcy Lilo, who was rumoured to be forming a pre-election coalition, introduces another element of uncertainty. Although Steve Abana's Democratic Alliance Party won the highest number of seats with seven MPs, their numbers are no guarantee that they will be able to form a coalition with independents. Changes of leadership in 2006 and 2011 sparked protests when voters suspected pressure and meddling from business. It is not out of the question that dissatisfied voters will take to the streets again to protest against the new leader or take part in opportunistic looting.

This period is a key test for the effectiveness of the RSIPF and the effectiveness of Regional Assistance Mission to Solomon Islands' (RAMSI) efforts to build law and order capacity. This is the first election since the withdrawal of RAMSI's military contingent and the draw-down of the police element.

Australia spent A$2.6 billion between 2003 and 2013 in the Solomon Islands. A$1.8 billion was spent on law and order. The RSIPF and RAMSI are taking no chances. The 150 RAMSI police in the country were boosted by 90 officers for the election period. High visibility operations have been carried out across the country and officers deployed to the provinces for polling day are being returned to Honiara. The business community in Honiara's Chinatown is also hedging its bets after the 2006 riots, when 95% of the shopping district was destroyed, by installing extra security measures and engaging more guards for the election period. 

Solomon Islands needs a solid government to drive reform and economic development, tackle corruption, resolve land disputes and lessen dependence on aid. It is by no means clear that the new parliament will deliver.

Photo courtesy of Wikipedia.

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Among the worries that keep Chinese leaders awake at night surely is food security. Li Keqiang's first priority upon taking the premiership in 2013 was agricultural modernisation. Civil rebellions and wars throughout China's history were fueled by the Malthusian need to keep people fed. As the nation now urbanises, the demands of keeping Chinese healthily nourished grow more acute. A spat over genetically modified (GM) food encapsulates the dilemma. 

Self-sufficiency has long been totemic and officially China meets an impressive 95% of directly-edible grain demand, almost 600 million tonnes annually. But with Chinese demand for meat already averaging 50kg per capita and approaching European levels for urban residents, China will need to import grains (mainly soybeans and corn) for animal feed, 120 million tonnes by 2020.

Yet with subsidies boosting rural incomes at US$75 billion or 11% of total output, domestic price support has perversely created high consumer prices and, surprisingly, a temporary 'grain glut.'

In seeking self-sufficiency, China has hit an ecological ceiling. Crop yields still lag, and only with unprecedented fertilizer application rates. Now the productivity crunch is being sharpened by shortages in three key areas: land, water, and labour.

Chinese often say that '22% of the world is fed with 7% of its arable land.' Urban sprawl has in a dozen years gobbled 8.3 million arable hectares (twice Japan's total arable land) and threatens China's 'red line' of 120 million hectares. Official statistics deny this threshold has been breached but cities have been ordered to stop paving over surrounding countryside. 40% of China's arable land has already suffered some degree of degradation. Water is becoming a constraint to food supply even as bureaucrats, incredibly, prioritise thirsty coal production. It might also seem odd that China faces a farm labour constraint, but migrants prefer life in the city. Chinese farming is a rotten business.

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The reason is simple: farmers can't own and can't sell their land, so their plots are tiny. The average dairy farm has seven cows. China doesn't do agriculture, as someone has wittily observed, it does 'gardening.' Fragmented farms and supply chains result in pork production costs twice America's. There are huge ideological and social barriers to outright rural land privatisation, but Beijing is gingerly experimenting with industrial farms. Factory farming is contentious, however, and some worry about China following the American model. In China itself, food safety scandals have alarmed the public.

Enter the GM controversy. 'Frankenfood' is furiously debated in many countries, but the squabble in China is unusually heated in a society where the state typically commands the agenda. In fact, in their pro-GM campaign, government scientists are visibly frustrated by the opposition, led by hawkish major-general Peng Guangqian who detects 'a monumental, supremely devious plot to annihilate the Chinese people.' Xenophobic conspiracy themes are perpetuated by nationalistic officials. Chu Xuping, a senior figure in the agency overseeing China's state-owned enterprises, rejects foreign investment in grain, pharmaceutical and water treatment SOEs. The dog-whistle message to the public is unmistakable: no Western fingers contaminating China's supply chain. (Incidentally a Chinese company owns Northumbrian Water in the UK).

China's GM rejection is rippling across world trade, visible recently in an ugly dispute over unapproved US GM corn. Beijing's stance may be geopolitically motivated, to allow a shift to friendlier Latin American sources. But there is also genuine concern about the sanctity of Chinese crop strains as GM seeds overrun the planet.

A close examination of president Xi Jinping's supportive pronouncements on the topic reveals what this is really about: 'We must boldly innovate the heights of GMO techniques, and we cannot let foreign companies dominate the GMO market.' An industry analyst is more blunt: 'The main reason for China's slow adoption of biotech grain crops isn't so much that the government is swayed by public opinion. It's that China doesn't have leading, marketable biotechnologies and is afraid of having the market controlled by foreign companies once commercialization is granted.'

Here is the nexus where land and water scarcity and concerns over food safety, social stability, industrial competitiveness and foreign dependence all meet. GM food is the sum of all China's fears.

Photo by Flickr user lenlners.

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