How Power Adapts to a Changed World

I will kick off this session by making a few observations using an analytical tool which we at the Lowy Institute in Sydney have developed over the course of two years – the Asia Power Index.

That will allow us to think through what might happen to the distribution of power globally – to the balance of power – as we move from an open and consensual world order to one defined more by competition and zero sum politics, certainly between the two largest players, the United States and China.

I have to confess my data sets is limited to the Indo-Pacific but we can extrapolate from this some global lessons to take forward in our discussion.

I will make three points:

One, is that under most plausible scenarios, short of conflict, I do not think the United States will be able to halt the narrowing power differential between itself and China.

Second, I think globalisation will still involve the United States and China but perhaps not the two together. That means a more hazardous variant of globalisation dominated by spheres of economic influence.

Third, I think under such circumstances middle powers in Asia, but also in Europe, become crucial in the overall balance, in terms of playing a third or intermediary role between two gridlocked superpowers. In other words, even if we are seeing a new Cold War between the US and China, I do not think we will see fixed blocks defined in the sense of the last Cold War.

Let me begin with a bit of history. In 1995 the largest global economies were the United States followed by a series of its treaty allies. Four of the world’s five largest economies were trans-Atlantic. It is staggering to see how Asia's transformation has shifted the distribution of economic power globally in the last two decades.

China’s economy went from about the size of Spain in 1995, surpassed Germany and France in the mid-2000s, and by 2009 overtook Japan as the second largest in the world. India – a bit more of a laggard – has experienced its own economic miracle of sorts in the last decade. By 2023, the IMF expects India to be the fifth largest economy globally. And that is just at market exchange rates because if you consider GDP at purchasing power parity we actually see that China is already larger than the United States by about a third.

So there we go. In geostrategic terms it is the relativities that matter and China's economic rise by definition imposes geostrategic costs for the US as the incumbent world power. Nevertheless, I think I should stress that the United States is not in absolute decline. It is in relative decline. That is an important distinction to make.

Now, it is not just economic resources that matter for our conceptualisation of international power. We think that there are at least eight thematic distinctions to be made when assessing state power.

There is military capability. There is also resilience, which is the capacity to deter real or potential threats to state stability. There are future trends in so far as the projected distribution of military, demographic and economic resources affects the perceptions of power today.

Crucially, it is not just what you have, but also what you do with what you have that matters – in terms of diplomatic networks, in terms of economic relationships, in terms of defence diplomacy, which acts as a force multiplier of military capability. And last but not least in terms of cultural influence.

So there are many variables involved here. In fact, we have about 120 indicators in total. When we aggregate all of those we come up with an outline of the distribution of power in Asia.

What is immediately apparent is that China and the United States are now firmly established as peer competitors. However, the US maintains a 10-point lead, some degree of primacy.

This is because even as China rises, and has established itself as the engine of Factory Asia, its power remains hobbled in key respects. Beijing has a lot of distrustful neighbours. It certainly does not have the defence clout that Washington has. America also brings soft power to the equation, as the biggest influencer in terms of exports of cultural goods and services into the region, but also with the way that current information and media flows are structured.

As such, hard and soft qualities of twentieth century US power endure in the early twenty-first century. These are rooted in a working system of cooperation, partnership and alliances, and are premised on the US underpinning that order as a multilateral player.

This is not just a two player game. If you look at how countries perform in terms of the interplay between resources and influence – basically what countries have, and what countries do with what they have – a good number of the second tier players register as overachievers relative to their size.

A city state like Singapore, with 5.6 million people, can be a standout overachiever in a rules based order that is largely consensual. That is because multilateral players work in coordination to pursue their interests. By contrast, misfit middle powers like Russia and North Korea, while powerful in their own right, lack broad based influence within a multilateral system.

So that is what the distribution of power looks like within an international order that is under stress but for the most part still ticking along.

It is coming under strain not just because of the narrowing power differential between the US and China but because of what has happened to US political leadership. President Donald Trump has made it clear that multilateralism is not his priority and when we asked a sample group of policymakers and experts in the region, they ranked the US leader thirteenth in the region in terms of ability to advance his country’s diplomatic interests in 2017.

Others have filled the void – not just China but also Japan and Singapore for example. In fact, middle powers are having to work much harder to maintain their comparative advantages. One example is how, after the US abandoned the Trans Pacific Partnership, Singapore and Japan were able to resuscitate the ambitious free trade agreement minus the United States.

Nevertheless, we do seem to be moving into a world defined by mercantilism and geopolitics – by a zero-sum as opposed to positive-sum logic. In that world a technological arms race starts to matter more, as does leveraging the power of the US dollar and the financial sanctions the US can invoke. Even trade and investment policy are being used in a much more geopolitical sense.

Now, it remains to be seen whether these are tidings which will be reversible or whether we really are moving into an era-defining moment. One where the US proclaims its mission in Asia to long-term geopolitical competition with China.

Let us assume that we are moving into what some people have called a new Cold War. That would require us to recalibrate some of our assumptions, our weightings strategy, for the Asia Power Index. So that is what we have done here. This is what power looks like today, and this is what we think power would look like under a new Cold War.

In a situation where rules-based globalism matters less than raw heft, we actually think that the US loses its comparative advantage as a multilateral player, and that China gains.

At the same time, smaller economies that are dependent on export driven models, such as Singapore and Malaysia, would suffer. More insulated economies that rely on domestic consumption do better. Indonesia moves up in the rankings, as does India.

This scenario for a new Cold War is premised on three assumptions.

The first is that there would be paralysis in economic governance. There would be no lowest common denominator, other than the agreement to disagree. We have seen signs of that at the G7 and at the latest APEC summit in Papua New Guinea, where leaders were unable to come up with even a diplomatic communique at the end. Things could get a lot worse.

By the end of this year, the rules based trading system built around the World Trade Organisation could wither if not crack under pressure. By December there will only be one judge left on the WTO’s Appellate Body, which means appeals and trade law enforcement will go into limbo. That will affect a lot of trade dependent countries, particularly smaller ones.

The second assumption I am making is that the US is serious about pursuing what has been called economic decoupling between the world's two largest economies. That would amount to a kind of reversal of globalisation in such a way that the US disentangles its companies and their technologies from China’s supply chains.

Now, it isn’t clear that will be possible to achieve, but allowing for that possibility, our model suggests that decoupling would have a limited impact on China's overall growth trajectory. The US could slow but not reverse China's ascendancy.

For this scenario, we have assumed a departure from current trends in 2018. Through the use of generalised tariffs, investment screening and other punitive measures – including possible targeted trade sanctions – the US would get very serious about open ended disentanglement from China in 2019.

That would produce a hit equivalent to about 3.5 percent of China's GDP, which is roughly the domestic value China gains from the exports it does to the US. It would also hit the United States. One could say – in a Trumpian beggar-thy-neighbour sense – that China would lose out more, and there would be a continuing long term growth hit. By 2030, China’s economy would be approximately 8% (or $2.7 trillion dollars) smaller than forecast under normal trends. The US would be $1.1 trillion dollars poorer too, with an economy more than 3% smaller than currently forecast for 2030.

However, my point here is that China’s overall growth trajectory is unlikely to be fundamentally affected. Thinking that you could contain the rise of China is not necessarily going to work. The reason is Beijing is much less vulnerable to escalating trade tensions than many believe.

China has become the world's largest trading nation. But counterintuitively its GDP has become less dependent on exports. The country’s trade-to-GDP ratio is around 38 percent. By comparison, Vietnam's trade to-GDP-ratio is over 200 percent. This suggests to me that China is less susceptible to the downsides of a trade war with the United States, but that the region, which by and large is strategically friendly to the US, may be much more so.

Similarly, in the technological arms race, there is obviously a concern in the West that China may at some point start to surpass the United States in terms of artificial intelligence, biotech and information technology. That may or may not happen. But China’s success or failure will have little to do with its access to Western markets, even if they chose to close themselves off to Chinese tech. If you look at the remarkable success of Huawei, the lion’s share of its revenues growth over the last five years has come from domestic sources and from emerging markets.

The point here is that I think Western markets may actually prove negligible to the global ascendancy of China's tech industry.

The third assumption I am making is that middle powers, particularly in Asia, will assert some form of strategic autonomy between the US and China. In other words, there will not be fixed blocks in this economic Cold War.

The US will be hard pressed finding regional friends willing to join it in decoupling from China. The reason is quite simple. China does about 70 percent more trade with the region than does the US. For major industrialised allies of the US – like Japan, South Korea and even Australia – decoupling plus America First is a toxic recipe. We want to see our ties with China managed but not necessarily severed.

Now the US has a range of carrots and sticks it can deploy in this so-called Cold War. On the one hand, it could promise to relocate supply chains out of China to emerging markets elsewhere in Southeast Asia. That is the carrot.

On the other hand, we have seen the inclusion of so-called poison pill clauses within recently renegotiated trade agreements, particularly the US-Mexico-Canada agreement, which would seek to reduce China's integration with America’s own economic partners.

However, a focus on securing bilateral trade deals and balancing trade flows one country at a time is unlikely to stem China's influence. It is simply too big. Far from containing China, forcing choices from third countries may ensure that global supply chains remain anchored in China after all.

Here is another chart that traces East Asian exports through to their source of final demand. In 2000, the West still accounted for about 50 percent of all East Asian exports in value added trade. Today, East Asia and non-western economies account for about two thirds of that balance. Asia’s economic transformation is resulting in a region becoming more self-dependent for its prosperity.

Now, how would these geoeconomic trends impact on the military balance of power?

Here is a bit of a global history since 2005 of defence spending trends. What we see is that China has climbed the ranks but not as drastically as it has been able to catch up to the United States in terms of its GDP.

Despite slower movement in the rankings, we would expect four out of the five top military spenders to be in the Indo-Pacific by 2023. This region is ground zero for great power relations globally. We cannot preclude the possibility that an economic Cold War risks turning into a hot war. There are plenty of historical examples of confrontations in economic terms that have escalated into physical conflict.

However, for the moment one of the hallmarks of the modern era has been that defence spending as a percent of GDP remains rather stable. So stable, in fact, that the US still enjoys a decisive advantage in terms of the military balance of power in Asia. It is not just the fact that US defence spending remains more than double the level of its next nearest rival but also the unrivalled hub and spoke alliance network that Washington brings to the table. At the same time, other regional players are essentially hedging against the military rise of China by pursuing more non allied partnerships and joint training exercises. Defence diplomacy is China's Achilles heel in Asia.

So our assessment of what a maritime conflict in East Asia would do to the balance of power is the following. Assuming the conflict takes place in the near future, the US would maintain a huge advantage. Countries with underdeveloped military power, notably Japan, would be more vulnerable. Ironically, New Zealand crops up in top 10. That is to do with the fact that it has geography on its side. The further removed you are from the physical conflict – the more friends and fish surround you – the more in some ways that you could endure a conflict. The more in the middle of the action that you find yourself, the more that your energy and trade security is potentially compromised.

So under current trends, I would think that the US maintains its military dominance in Asia, until 2030 and beyond. However, this assumes China's ratio of defence spending to GDP remains largely unchanged for the next decade.  

Under a period of building and prolonged tension, in a way more reminiscent of the last Cold War, I would assume that China could in fact ramp up its defence spending from an estimated 1.9 percent currently to over 4 percent of GDP. Under this scenario, China may have more fiscal headspace to catch up with the United States.

Long-term political will and defence economics will be deciding factors in the military rivalry between the peer competitors. And let us keep in mind that the United States has commitments that are spread across the globe, of which it is increasingly sceptical, whereas China can concentrate its resources on Asia.

I will finish my presentation with three concluding points.

First, I do not think the United States can, or even really should, attempt to prevent China's emergence as a peer competitor. There is no reason to assume China will replace the United States as an undisputed unipolar power, at least not in Asia. However, there are potential aggravating consequences – economically and militarily – of pursuing a new Cold War strategy unilaterally through zero sum politics.

Second, I would think the US would need to find a way to live with China by playing to its strengths as a multilateral player. This would be more conducive to an environment where the strengths of US allies and partners are maximised.

Third, China will continue to chip away at America's margin of pre-eminence. But let us also keep in mind that the rise of India will mean that that New Delhi will start chipping away at the relativities of Beijing's power, particularly as China starts to age.

I will leave the rest to our discussion. Thank you.