Economic Experiments and the Battle for East Asia

After a last minute budget deal on Wednesday, Oct. 16, the United States government is back in business. Among the casualties of the 16-day shutdown, which resulted in at least $24 billion in U.S. economic losses, was a presidential trip to Southeast Asia.

Stuck in Washington in early October, media coverage, and even President Barack Obama himself, described how presidential absence from Asia benefited Beijing. Adding insult to injury, a group photo from a regional forum that Obama was supposed to have attended showed Chinese President Xi Jinping smiling front and center, while protocol banished Secretary of State John Kerry -- filling in for Obama -- to a back corner. "Obama cancels Asia trip. Is the US 'pivot' in jeopardy?" ran aheadline from The Christian Science Monitor.

While China emerged victorious from this latest round of diplo-drama, the handwringing in Washington misses the point: The contest for influence in Asia will not be settled in multilateral meetings. Instead, the region will be shaped by whichever major powers have the best prospects for long-term sustainable growth.

Simply put, power costs money. As the economic heavyweight of the 20th century, the United States has had the resources to build a system of military alliances in Asia and to advance U.S. interests in democracy and free markets. But today, the region is up for grabs. Over the next four months, the United States, China, and Japan -- the world's three largest economies -- are all potentially instituting game-changing economic reforms, whose outcomes could determine who leads Asia.

China's economy could become roughly the same size as the United States in purchasing power parity (PPP) terms as early as 2016, according to the Organization for Economic Co-operation and Development (OECD). And the National Intelligence Council, the U.S. intelligence community's center for long-term analysis, has estimated that China's economy will be the world's largest in aggregate terms before 2030. Already the second largest or largest trading partner to every major country in Asia, China uses its economic leverage to garner support on issues like Taiwan while muting international criticism over continued human rights abuses. And in March, Chinaannounced its military budget would expand by 10.7 percent in 2013, continuing two decades of double-digit growth and buying increasing capability to contest disputed territories in the South and East China Seas. 

But China is simultaneously in the midst of its longest economic slowdown since the introduction of market reforms in the late 1970s. After enjoying double-digit growth for much of the past three decades, its gross domestic product (GDP) is expected to expand at roughly 7.5 percent in 2013. With China facing rising labor costs, an aging population, endemic corruption, pollution, and theconsequences of transitioning from a low- to middle-income country, Peking University professor Michael Pettis believes its annual GDP growth could drop as low as 3 percent over the next decade. The 2009 financial crisis further exacerbated these vulnerabilities by decreasing overseas demand and spooking Beijing into enacting a $570 billion stimulus. While that program temporarily propped up the economy, it also contributed to a serious local debt problem, now estimated at $3.28 trillion, nearly 39 percent of GDP.

Communist Party leaders, aware that China's current growth model is unsustainable, have been unequivocal about their desire to replace overreliance on debt and investment with greater household consumption. With that in mind, China's official news agency Xinhua billed the Third Plenum, a major party conference in November, as "a springboard for major national reform." But itremains to be seen whether the Party has the will or the wherewithal to take on the vested interests that profit so handsomely from the existing system. It is looking increasingly likely, for example, that the Party will defer reform of state-owned enterprises, seen by many as the linchpin to revitalizing China's economy. If China gets bogged down in domestic economic problems, it will be less able to project power overseas.

Meanwhile, across the Pacific, Japan has been plagued by two decades of abysmal economic growth.

In January, a month after taking office, Japanese Prime Minister Shinzo Abe announced "three arrows" of monetary, fiscal, and structural reform. The first two are already underway: In February, Abe launched an unprecedented program of monetary easing by the central bank, which quickly resulted in a doubling of the monetary base. This was accompanied by the second arrow, a massive$116 billion fiscal stimulus program to drive demand.

Early results have been promising -- the economy grew at 3.8 percent in the second quarter of 2013 -- but the long-term success of Abenomics lies with the third arrow, structural reform. Japan's economy remains over-regulated, inflexible, and unfriendly to foreign firms. (The tariff on imported rice, for example, is a whopping 778 percent.) And the reforms may not be able to overcomethe extraordinary weight of Japan's increasingly aged population and debilitating debt-- expectedto hit 230 percent by 2014 (the highest debt-to-GDP ratio in the world).

Abe has already visited Southeast Asia, where Japan is a leading donor and investor, four times since December. But visits alone will not suffice. The more Abe is able to put Japan on a solid economic footing, the more the country will be able to play a decisive role in the region. If Abe's reforms succeed, he may accrue enough economic and political capital to beef up Japan's military and amend its pacifist constitution. This could become increasingly important to supplement reductions in U.S. defense budgets.

 Obama faces the daunting task of jumpstarting the U.S. economy while addressing the longer-term challenge of curbing the federal debt, which exploded from 32 percent of GDP in 2001 to 72 percent in 2012. Over the next decade, the United States faces a total projected deficit of $6.3 trillion as the spending pressures associated with an aging population, rising health care costs and growing interest payments continue to outpace revenue.

 A United States suffering prolonged economic woes will find it increasingly difficult to maintain the diplomatic, economic and military power it has sustained in Asia since the end of World War II. Smaller defense budgets will corrode the U.S. military presence in the region. Despite sound fundamentals for growth, the failure to break the gridlock in Washington and put the United States on a sustainable fiscal footing could imperil its ability to patrol and pacify East Asia. The isolationism that often accompanies tough economic times would further reinforce the erosion of American influence.  

Kicking off the U.S. pivot to Asia in November 2011, President Obama told the Australian Parliament that, "let there be no doubt: In the Asia Pacific in the 21st century, the United States of America is all in." Maybe so, but current reform efforts in Beijing, Tokyo, and Washington will help to determine who's playing the strongest hand. 

Ely Ratner is deputy director of the Asia-Pacific security program at the Center for a New American Security.