© REUTERS/Umit Bektas

1. At its core, systemic competition with China consists of rival visions of human nature. The European ideal of the autonomous individual, responsible for its own actions, has come under severe threat by digitally-driven behavioral conditioning. However, from a Chinese point of view, the Enlightenment view of human nature is a transient historical phenomenon, a luxury that only a few wealthy societies can afford.

In our epoch of interactive digital media, gamification and artificial intelligence, the autonomous individual—capable of thinking, deciding and acting for itself—has been increasingly called into question. That individualistic figure had underpinned the Enlightenment’s optimistic vision of human nature. But today, vast quantities of data amassed by digital platforms and the gaming and advertising industries have proven the extent to which human desires and preferences can in fact be exploited and manipulated, as well as analyzed for their supra-individual properties. It is also increasingly clear how easily most “netizens” can be influenced by the targeted manipulation of information and human emotions. Networks of influencers and followers—in other words, digital thought leaders and acolytes—are by now a powerful vehicle to steer collective mimetic behavior.

To use a rather pointed metaphor: the ecosystems of interactive apps are a playground for modern herd behavior among humans. This herd behavior can be observed in the imitation of prefabricated lifestyles, fashions and looks, but it also extends to individual positions taken on divisive, in-or-out questions, and to forms of collective online denunciation, aggression, and hatred. What confronts us in social media, the gaming industry, and digital advertising are not images of self-aware, mature individuals. We are witnesses to a pandemic of herd behavior.

In a vast number of experimental studies, neuroscience and behavioral economics have demonstrated that herd and mimetic behavior remains a determining element of human nature, notwithstanding the great efforts made by state and society toward individual education, freedom of decision, and self-responsibility. The reestablishment of authoritarian and totalitarian modes of social order has its basis in collective needs for security and order and in herd behavior that is prompted by sheer terror or mass fear. In this way, the digital proliferation of herd behavior benefits the social engineering of the Chinese Communist Party, which it is now deploying with ever greater confidence and championing elsewhere in the world.

2. The CCP’s design for social order is based on a vision of human nature compatible with both Leninist principles and the digital age. Human beings are understood as herd creatures requiring guidance and steering. Under the guidance of a wise, strong Great Herdsman, the herd can be formed into a placid, productive, and technologically innovative society, but only as long as it is protected by vigilant herding dogs and has its agility maintained by loyal junior herdsmen.

China’s communist revolutionaries and the founders of the People’s Republic always rejected Western individualism as a bourgeois smokescreen; they thought close control of the “masses” by a political avantgarde to be essential. However, Mao Zedong and Deng Xiaoping never had access to the digital technologies of power that Xi Jinping relies on today. China’s model for digital civilization consists of an agile hierarchical order, deploying targeted, seamless digital control technologies in order to steer a conflict-prone mass society down well-defined political paths. As it currently stands, this Chinese model offers a worryingly productive combination of political and commercial conditioning with economic and technological agility. This sort of social order appears particularly compatible with the possibilities inherent to our emerging digital civilization. It can potentially serve as an example for other governments and societies also in search of political stability and economic prosperity.

3. Platform corporations like Alibaba or Tencent and innovation champions like Huawei function as authorized “junior herdsmen.” Under close observation by central political authorities, they must pass on unlimited quantities of data to state bodies for evaluation and control.

The metaphor of herd behavior also applies to other specificities of the Chinese context. The system of herd control, which China quite deliberately brought into being, is led by wise herdsmen: the party leader and the central governing ranks of the CCP. For controlling the herd, the central authorities rely on a division of labor between “junior herdsmen” and “herding dogs.” This is necessary since herd society requires carefully-supported pioneers and role models, who for their part remain agile and innovative. Individual pioneering acts of innovation, in particular in the economy, technology, and science, are publicized in so far as they are socially and politically useful within officially-established parameters. In this context, popular online idols created by the system serve to popularize overarching regime goals, including unquestioned nationalism and unconstrained enthusiasm for technology.

From the perspective central authorities, China’s pioneers should on no account be independent, freewheeling thinkers. Instead, they should desire to emerge from the herd, ascending to high-ranking positions in the official order, while never calling political hierarchies into question. Status and rank within the herd are acceptable values; individual power or even political freedom are not. Jack Ma, founder of Alibaba and a model member of the Communist Party, exemplifies this behavioral pattern: a loyal idol for the digital age.

All of this takes place under the watchful eyes of powerful herding dogs (cyber-administrations at every governmental level, digitally-upgraded state security bodies, state-run cloud operating companies, etc.). When in doubt, the authorities will bite quickly and hard to enforce subordination and discipline. The overall guardians are under instruction to allow considerable freedom of action to junior herdsmen who function as pioneers. The search for new grazing grounds (markets) and new nutritional sources (raw materials, products, business models) is of paramount importance to the highest-ranking herders to make the herd system prosper and expand.

4. The Chinese state, well-equipped with digital technologies, is becoming an agile conditioning apparatus impacting both society and the economy.

The Communist Party has powerful instruments at its disposal: AI-based facial, voice and gait recognition and analytic cameras in public spaces, as well as the ubiquitous smartphone, providing a constant supply of data on individual mobility, communications, and transactions. In part, this can be seen as a matter of surveillance and of early recognition of actual or presumed aberrant behavior. This entails an ongoing analysis of the unending data streams produced by all human interactions. On this basis, individual and collective behavior is regulated. Incentives and sanctions are used to shift overall behavior in the desired direction. All individuals and all legal entities, including official bodies, generate permanently updated data sets, which can in turn be used to evaluate and regulate their conduct. Political, social, and economic trustworthiness is no longer generated through human interaction or formal laws and contracts. Rather it emerges from the data streams and evaluations of trustworthiness apps—in other words through state-organized “social scoring.”

“Big Brother” or “Sauron’s Eye” are inadequate metaphors for this system of control. China’s rulers are aiming to have people internalize the system to such a degree that they no longer even perceive how much the Party controls them. Thereafter, inner resistance will no longer exist. External regulation and control at a distance are meant to become a self-evident and accepted part of life. So if the planners in Beijing have their way, a self-operating surveillance system may come into being, eventually meaning almost no need for police. Breaches of the rules will be socially proscribed, with no active participation on the part of state authorities. Each and every person in society must conform and practice self-discipline, otherwise they lose their trustworthiness ranking and are automatically forced out of society. Used in China’s unconstrained way, digital technology allows for constantly intensifying and granular behavioral control not imposed by a superior authority, but rather anchored and executed within the social fabric.

5. AI is a perfect instrument in the hands of a communist party.

Artificial Intelligence offers the possibility of centralized analysis of huge quantities of data, allowing the recognition of patterns and deviations, and systems of centralized regulation, all without active human participation. The particular strength of AI consists of producing optimized regulatory results for the largest possible population—in other words, it can overcome the chaotic, self-seeking individual pursuit of happiness. These ambitions have been among the central goals of communist revolutionaries since the early 20th century. This is why the IT investor Peter Thiel has accurately characterized AI as “communist.”

But after an initial phase of testing and optimization, AI will also be able to function without the deficient human organization of a communist party. For this reason, China can arrange to have its model of social order installed in other countries and societies without having first to develop a local party-state machine. In its enhanced, 21st-century form, AI will reconstitute the communist agenda of a collectivized, conflict-free society, a vision that was an utter failure during the 20th century. Moreover, it will do so much more effectively than any authoritarian party-state, past or present. Thanks to AI, the original vision of early 20th-century communist revolutionaries will at last come within reach: centralized planning, control, and programming of economy and society, aimed at overcoming all social defects and conflicts, both contemporary and historical.

6. The Chinese panopticon currently emerging arose as the realization of a Leninist dream: at any time, anyone can be observed by the central authorities. This will make possible the formation of a “New Human Being.”
Jeremy Bentham first described the idea of the “panopticon,” a method for enabling the perfect surveillance of large numbers of people by a single overseer. In the industrial age, as a result of cumbersome, large organizations, mass deviance from the norm, and many observational blind spots, this vision could never be consistently realized. However, the fusion of new digital technologies with the more traditional control instruments of Communist Party rule is preparing the way for a substantially more effective Digital Leninism that is currently taking shape in China. In the Chinese system of surveillance and conditioning, the individual cannot know with certainty whether he is actually under observation. But he knows that he is visible at all times, always observable: he thus will have to adapt his behavior in a kind of preemptive obedience.

Behind the ambitions of the Chinese social credit system, we can discern the idea of the “New Human Being”: the dream of a civilization in which human behavior is changed to such an extent that it becomes a lasting collective form, entirely compatible with the broader aims of those in charge. The new trustworthiness system—unlike traditional power instruments like mass mobilization and state terror —is being sold to the Chinese people as technological progress, purported to make the individual’s life easier, safer, and more transparent. In fact, the new developments have been hailed by many, who wish to use, for example, a scoring app to find out whether the person they are meeting or the delivery company they are contracting is worthy of trust. In this assessment, however, one’s own judgment plays no further role. The grounds for evaluation now consist of ostensibly objective data profiles.

7. If we do not oppose the penetration of digital manipulation of preferences and behaviors more effectively than hitherto, time will bring the essence of Chinese developments to our own society: a politically and commercially fabricated and regulated herd organization.

With the pandemic of herd behavior in the digital age, the Chinese government’s vision of human nature has concrete potential to gain ground in many other societies. Systemic competition between China and the West—which first played out mainly in economic and technological realms—is now escalating in politics and ideology. That particular conflict focuses on fundamentally differing conceptions of human nature.
If, in the medium term, China turns out to be the superior economic and technological system, with China’s economy possibly double the size of the United States by 2050, it will have undoubted global consequences for 21st-century governance. Chinese views of society and economy as a herd order in need of surveillance and regulation may prove victorious around the world. And China will reveal itself to be the political and economic system that can make use of the whole range of possibilities within digital civilization the most effectively.

For these reasons, systemic competition with China turns on questions that are even more fundamental than political institutions, technological competition, and security threats. It is a question of the roles and rights of human beings in a future society. China is offering an alternative form of social order, aiming at omnipresent digital conditioning and granular behavioral control. This stands in radical contradiction to the vision of human nature dominant in liberal democracies and market economies.
However, the Chinese conception of ordering human beings, society, markets, and government is gaining attractiveness in many developing countries and emerging markets. China can promise comprehensive technological solutions for politically unstable, economically less productive and conflict-ridden societies, in particular in order to reorganize the wildly proliferating metropolitan areas, now often housing more than 15 million people. The tried and tested systemic solutions that China offers for managing megacities can address infrastructure, living conditions, mobility, energy, environment, and security. Chinese surveillance techniques for public spaces and for online communication have already been deployed in at least 18 separate countries.

Europeans criminally underestimate the strength of demand in many countries for Chinese “smart city” models, including infrastructure and security technology. We cannot rule out in advance that the Chinese-designed systems of authority may allow for peace, wellbeing, and even environmental sustainability in an increasingly densely populated and conflict-prone planet. But if current Chinese conceptions and practices of social engineering come to proliferate globally, the ideas of human freedom and self-determination will head for their digital demise.

8. What can freedom-loving societies do to counter the global advance of Chinese-style digital social engineering?

If we Europeans want to defend what we have struggled to achieve over centuries—individual freedom and choice—the digital transformation will prove an obstacle in many areas of life. European data protection regulations are an expression of this conflict. China’s social scoring system and surveillance state offer a counter-model. Even in China, it is not at all certain that social and political conformity can be implemented without resistance, as suggested by Chinese planners. The large-scale technical systems on which Digital Leninism is based are highly vulnerable. And the social reactions to omnipresent surveillance systems and behavior control will likely become manifest only when systems extend over all areas of life and offer no escape, not even within the most mundane scenes of daily life.
But it would be irresponsible to rely on a stumble, even a collapse, of the Chinese system. In the past, the CCP has repeatedly startled us with its capacity for learning and adaptation. For this reason, we cannot pin our hopes on a Chinese collapse. Rather, what we need to work hard at is a purposive and consistent separation between European and Chinese models of digital control in spite of possible economic costs and political conflicts in relations with China. The discussion on the role of Huawei, the Chinese telecoms equipment supplier, in the development of European 5G networks is only the beginning. Subsequently, we must address the worldwide communications, transactions, and data analysis that are enabled in particular by Tencent’s app “WeChat” and Alibaba’s e-commerce empire. Alibaba and Tencent are dominant ecosystems, not only within China itself, but also for the million-strong Chinese diaspora who all send enormous quantities of data to state-controlled server systems in China.

The fight, however, must not only be fought against manipulative uses of data coming from abroad. On the domestic front, we need to take on the predominantly US-based platform enterprises and targeted data services that have come to dominate the markets. Europe can only achieve its much invoked “digital sovereignty” if it prevents unacceptable practices of data collection and behavior manipulation by suppliers inside and outside Europe. Perhaps most importantly, as a precondition to even think about “digital sovereignty,” Europe needs to nourish the emergence of digital business models for its large domestic market that offers competitive services without destroying free societies.

The decisive question is whether European people, societies, and political institutions can find the strength to at least defend and preserve the core areas of freedom of decision in the manipulative world of digital platforms. Many concrete practical measures are on offer and are ready for implementation. Parts of European society and official regulators are pushing back hard against behavioral conditioning and herd behavior. Because why would any rational person want to be reduced to the human equivalent of sheep, lemmings, or even insects?

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© REUTERS/Fabian Bimmer

The German export-oriented economic model is under attack this year: Germany is caught between tough American protectionism and aggressive Chinese industrial policy. The US government is threatening to impose painful sanctions on key German export goods, such as automobiles, while China’s industrial policy is focused on acquiring important industrial technologies, and eventually replacing existing foreign technology leaders in the automotive, engineering, and chemical industries.

Because of the sizes of their markets, the United States and China unquestionably have the tools to hurt Germany’s export-oriented economy. The new German government under Angela Merkel will have to counter the effects of the US-Chinese squeeze.

First, German dependence on exports to the United States and China must be reduced. The focus should be on strengthening growth forces – and not just in Germany, but Europe as well. All euro area countries except France, Finland, Cyprus, and Belgium have current account surpluses, , and Germany’s surplus amounts to almost 8 percent of its GDP. The euro area as a whole has a surplus of around 3 percent of GDP. These external surpluses are no longer sustainable in a world in which the US president is threatening to launch a trade war and the World Trade Organization can no longer regulate open markets in key economies.

Germany’s capital investment is lagging behind. Even without this acute pressure, it would be in Germany’s interests to set domestic growth forces free. German business investment has been weakening for years. German gross investment in the industrial sector has been lower even than in France or Italy since the start of the millennium. A timely and feasible step would be to massively improve the rules for depreciating assets on capital, software, and research investments in the German tax code. This is all the more necessary now as US corporate tax reform will allow companies to immediately depreciate 100 percent of their expense for equipment and building upgrades.

Beyond reforming the tax code and lowering other regulatory barriers, Germany will have to accelerate the development of public infrastructure. Improvements are urgently needed for the country’s roads and public transport infrastructure, as well as its data infrastructure and broadband network. Schools and universities could use more funding as well. The increased availability of both private and public capital will also help raise wage levels in Germany. After all, capital complements most labor activity. This set of measures would promote domestic growth and reduce dependence on exports; the resulting growth in Germany would also help its EU partner countries by increasing demand for their products.

Promoting Infant Industries

Second, German innovation policy must also make a real leap forward, especially in the digital economy, so as not to leave the future of technological change entirely to others. American and Chinese IT corporations are in the process of dividing up world markets, setting technological standards that will be associated with huge licensing revenues in the future. They are also making significant advances towards the technology of the (near) future: artificial intelligence.

At the moment, neither Germany nor Europe has a lot to offer in terms of a digital economy. The EU’s Digital Single Market is not progressing. As early as 2019, Europeans will become painfully aware of the shortcomings in their networks’ innovation policies when the Chinese company Huawei begins to install 5G mobile technologies in Europe, a prerequisite for networked industrial production and autonomous driving.

Europe needs a much more ambitious and active digital innovation policy, one that includes the targeted promotion of European “infant industries,” for example through the development of larger venture capital markets. Research shows that scaling companies is more difficult in Europe than in the US due to lower access to venture capital in all industries. With regards to critical infrastructures, there should be no taboo on the targeted support of currently weak European 5G developers, such as Nokia or Ericsson. If European semiconductor and mobile network companies disappeared from the markets, after all, dependencies on US and Chinese technology providers would not only create security risks, but would permanently reduce European innovation capacities.

European governments will therefore need to fundamentally rethink their innovation policies, and in particular their digital policies, in order to counter the rush of American and Chinese companies and innovations. The German coalition agreement does hint at the importance of research, but it gives the impression that rather marginal changes are being considered, when a qualitative change is needed. Company- and market-driven “innovation from below” will be necessary but insufficient; digital transformation requires new, state-financed infrastructures, targeted support measures, and educational offers as well as continuously adapted market rules provided by governments and parliaments. Public innovation policy must simply become more ambitious and think in terms of bigger goals and dimensions. Substantially strengthening research and development spending in the European and German budgets is only a first necessary step in this direction.

Screening Foreign Investments

Third, Germany should campaign for a robust foreign trade policy in Europe. On the one hand, this is about adequately examining security interests in foreign investments and acquisitions and flanking them with a pan-European coordination office. On the other hand, it is also about protecting strategic technologies from being taken over through market manipulation practices. For this task, the competencies of the EU Directorate-General for Competition should be strengthened. It is completely unacceptable that foreign top dogs operating with state funding from closed domestic markets should be able to drive European companies out of the European market.

Germany must stand up for open markets and fair trade practices more decisively than before through the EU’s Directorate-General for Trade, without weakening the European institutions through unilateral action. European Trade Commissioner Cecilia Malmström is doing a very good job, not only in her negotiations with the United States and China, but also in establishing new strategic trade relations with, for example, the Latin American Mercosur, along with a free trade agreement with Japan. Europe should build further partnerships and, at the same time, sharpen its trade policy instruments to defend itself in the case of conflict and represent European interests more effectively than before.

Germany can no longer avoid an economic policy correction in the face of the dual pressure coming from the United States and China. The new German government has to act now if it wants to defend domestic industries from unfair competition while releasing Europe’s own growth forces.

The post Squeezed Model appeared first on Berlin Policy Journal - Blog.

Artwork: Dominik Herrmann

As a result, uncertainty is increasing regarding China’s contribution to global demand and growth. Chinese output, investment, exports, and prices are not in free fall so far, and market volatility and government interventions in China’s stock markets are no indicator of the overall state of the real economy. However, signs of an impending crisis are growing in many sectors of the real economy, most obviously in construction, heavy industry, and commodities. The drop in producer prices in industry reveals deflationary tendencies. It is a result of both decreasing input (commodities) prices and vast industrial over-capacities in many branches of China’s industry. In micro-economic terms, industrial crisis manifests itself as worsening payment practices on the part of Chinese companies and as cuts in production in the construction industry and shipbuilding, albeit thus far without massive waves of redundancies.

A number of positive trends complicate any simple doom and gloom predictions: Strong forces of growth are at work in the service and health industries, as well as in web business and consumer demand. Thanks to new financing opportunities and relaxed regulations, many urban and – surprisingly – rural areas have seen a real boom in the creation of SMEs (though with uncertain consequences for actual growth and employment). There have also recently been signs of recovery in property prices in many large cities.

In the short and medium term, however, these new sources of growth will not be capable of compensating for pronounced weaknesses in traditional sectors that have driven growth over the last two decades, now putting immense pressure on the government’s economic policies.

Moreover, the government’s policy response has been unusually hesitant and inconsistent. Contradicting signals and interventions from financial market regulators and the central bank have unsettled investors and consumers alike. Popular trust in Chinese leadership’s economic competence, capacity for action, and drive for reform has taken a severe knock. And the stability of the financial and fiscal system has been called into question as a result of the rapidly growing debt burden carried by local governments and state-run private businesses: the central government’s ability to pay off these debts is in a much worse state than incomplete official budgetary figures would suggest.

The most important questions in the medium term, however, concern the resolve and ability of Chinese leaders under Xi Jinping and Li Keqiang (the “Xi-Li administration”) to actually implement the comprehensive program of economic restructuring and liberalization that the Communist Party’s Central Committee announced in 2013. The impetus for reform currently seems unpredictable. Further steps in crucial areas due for reform, such as state enterprises or central-local fiscal relations, have not made substantial headway yet. The economic events of 2015 have made one thing clear: compared to previous economic downturns, the Chinese government is now much less effective in steering business, investor, and consumer behavior through direct interventions.

If China’s growth keeps dropping, and reforms fail to materialize, the slowdown in the country might have long-lasting negative effects on a global economy already under pressure.

The “New Normal”

The Xi-Li administration’s predicted development scenario for China’s switch to a new growth model has been dubbed the “new normal”: growth will fall slowly over several years, eventually reaching a plateau at a lower, yet more sustainable and resource-saving level with the help of politically controlled, state-supported, socially viable steps.

The current accelerated downward trend was not part of the plan: a slump of this kind can result in an increased risk of social and political destabilization. However, the experiences of economies that have undergone fundamental structural change in the past (particularly former state economies) is instructive for the Chinese case: China may have to go through a so-called “J” curve, a temporary drop in economic output followed by another dynamic phase spurred by new growth drivers.

This temporary drop in growth associated with structural reform is difficult to sell politically in any kind of regime – the ruling government generally takes the blame and faces a loss of public support. In democratic systems, the government that initiated the policy shift is often voted out; former SPD chancellor Gerhard Schröder’s government and its reformist “Agenda 2010” may be seen as a textbook example of this phenomenon.

For China’s political leadership, however, the political risks of a “J” curve are understandably unacceptable: the Chinese Communist Party cannot possibly tolerate the risks of social and political destabilization that are associated with a curve of this kind. As the CCP cannot be voted out, such a scenario would put the entire political system as it stands in danger.
As a result, it is highly likely that the Chinese government will resort to new stimulus programs should the current downward economic trend become too negative rather than risking social destabilization and the resulting loss of political support and power.

Best-Case Scenario: the Spoon Curve

The dynamics and consequences associated with the J curve are politically worrisome. But China’s economy has the potential to overcome the trough and subsequent rise in growth more quickly than most transition economies we have seen in the past – thanks to continuing growth dynamics in the consumer, service, and health sectors along with private and internet-based industries, the country may just go through a mild variation of a structural adjustment crisis known as a spoon curve. However, to ensure this growth pattern, China’s government will have to press ahead with deregulation for private and foreign investors in sectors that have been characterized in the past by protectionism, or have been state monopolies and oligopolies until now.

A spoon curve of this kind would involve a temporary, moderate drop in growth, followed by a slight rise that would level out into a plateau, one that represents much more modest growth than China has experienced in the past, but which should also be more sustainable. This currently appears to be the best possible scenario for China’s transition to a new growth model. This paradigm, however, implies a fundamental transfer of assets, financial resources, and decision-making powers away from governmental bodies to private firms, investors, and households. As such a drastic strengthening of the private sector at the expense of state control is unlikely to be politically acceptable to the current administration, a spoon curve is not very likely to be the course the government will actively support.

The pressure on China’s government to allow drastic deregulation, liberalization, and privatization of the economy, despite current political and ideological resistance, could increase if downward trends in the economy accelerate.

The Most Dangerous Scenario

The most dangerous economic and political scenario would be for growth to plunge in 2016-17 without substantial new growth forces appearing to cushion a hard landing. This type of rapid, negative development within a short time would present a high risk of political and economic disruption across China. A hard landing of this type would, in all likelihood, be associated with a loss of unity and capacity to act on the part of the political leadership.

This worst-case scenario cannot be ruled out if external shocks (like a global financial crisis accompanied by a global downturn in demand) start to affect the Chinese economy. As a result of the current weak state of the global economy and its current lack of growth engines, a hard landing in China would have fatal knock-on effects globally.
Looking at the current situation, the likelihood of this worst-case scenario coming to pass is actually quite low – a catastrophe of this kind would only occur if destabilizing domestic and global economic events combined with severe internal and/or international political tensions.

Most Likely: Deferred Change

Due to economic and political restrictions, neither the “new normal” nor the spoon curve appear achievable at the moment. This leads to an alternative possibility, one that has already been realized in the largest economies since the onset of the global financial and economic crisis in 2007. This approach to economic policy takes the form of government- and central bank-sponsored stimulus and stabilization packages. It utilizes different variants of “quantitative easing” with the aim of deferring inevitable but risky re-regulation and restructuring in the economy, which would carry uncomfortable political consequences. At its core, this approach aims to avoid political trouble, instead buying time for structural adjustments to be made later under more favorable macroeconomic conditions.

In China, this pattern of deferred adjustment took the form of a huge stimulus package amounting to 14 percent of the country’s total GDP between 2008 and 2011. The consequences were a flood of loans and investments not reviewed for viability, and the creation of huge levels of excess capacity in industry and physical infrastructure. As a result, China has to face a quickly growing debt burden, the formation of investment bubbles, excess industrial capacity, a slump in producer prices with a tendency toward deflation, and the likelihood of medium- to long-term stagnation. China’s long-lasting, extremely high levels of investment generate less and less growth. State-controlled investment tends to concentrate on established industries and the state sector, with only a limited percentage going to future growth industries and the private sector.

Starting from a political calculus, renewed stimulus packages remain attractive, as any steps toward the inevitable changes ahead can be deferred. Consequently, this approach seems to be the most likely as things stand in the Xi-Li administration’s economic policy once it becomes clear that the controlled structural change referred to as the “new normal” cannot be implemented successfully – and thus the political and social risks involved in this type of economic development threaten to spiral out of control.

This process – stimulus, debt, excess capacity, deflation, and finally stagnation – displays similarities with Japan’s macro-economic experiences since the early 1990s. Unlike in Japan, however, medium- and long-term stagnation in China is likely to be associated with a much larger risk of social and political destabilization. The extremely ambitious Chinese population is characterized by having disparately high expectations with regard to its economic future: promised growth is an essential part of the tacit agreement between the CCP and China’s middle and upper classes. The deferral of structural reform and the advent of stagnation, therefore, would severely aggravate social and political tensions, and likely result in systemic disruption.
Repercussions on Economic Interactions

China’s function as a global growth engine is under question, and a long-lasting or abrupt drop in demand from China would have far-reaching consequences for the global economy.
The slump in Chinese demand is already having highly negative consequences on global commodity prices and on the country’s suppliers, from Brazil, Australia, and Indonesia to Angola, Nigeria, and South Africa. Moreover, trade relationships with leading global export economies such as Germany, Japan, and South Korea have seen unusual downward pressure in 2015 in previously very sound sectors.

Foreign currency and financial markets are also being affected by the slowdown in Chinese growth. Weakening Chinese demand for commodities, in particular, aggravates the negative impact on emerging markets of an expected interest rate rise from the United States. Both factors work to increase capital drain, currency depreciation, and debt servicing pressures in emerging markets.
A slump in China will likely result in a reorientation of international funding initiatives launched by the Chinese government, too. The profitability of foreign investments made by state banks or state enterprises and the government’s capital injections in the framework of the Asian Infrastructure Investment Bank (AIIB) or the Silk Road initiative will become urgent and contested issues within China. Many of the recent large-scale outbound funding initiatives will be subject to much stricter scrutiny in the context of an internal economic downturn.

In any event, support and financing for domestic structural adjustments in China will be given priority over investment and involvement in high-risk countries such as Pakistan, Venezuela, and Zimbabwe. Should China’s domestic economy experience a hard landing, a reduction or reversal of costly geopolitical ambitions, especially the Silk Road initiative, will appear on the political agenda.
At the same time, current negotiations between the Chinese government and the US and the EU regarding enhanced investment and trade agreements can be positively accelerated in the context of a demand crisis in the Chinese and global economy. All trading nations will have to become more resolute in breaking down investment and trade barriers so as to counteract a contraction in world trade and global growth.

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(c) MERICS

The Shifting Context of China Policy

While China’s long-established relations with Western states and markets remain indispensable, the country is trying to find ways around Western influence and is strengthening its relations with non-Western powers. This includes major challengers of the West, such as Russia, along with smaller marginalized countries, such as Venezuela or Zimbabwe. China is also no longer willing to limit itself to Western-dominated international institutions. It is therefore currently building a broad range of parallel alternative mechanisms that bypass the US-led, post-Cold War order. In the Asia-Pacific region, the long-downplayed great power rivalry between China and the US is a blunt fact today, encroaching on all regional interactions.

Domestically, China’s political leadership is taking a much tougher approach, not just against internal corruption and dissent, but also against long-established forms of civil society cooperation with foreign organizations. A number of non-governmental communication channels with China that had worked without interruption for decades – including Western NGOs and foundations – currently find themselves under suspicion of belonging to “hostile foreign forces” working toward undermining Communist Party rule.

On the economic front, Chinese growth is markedly slowing, and major sectors such as property, construction, finance, and manufacturing appear increasingly fragile. Overcapacities and cut-throat price competition are making China’s business environment much more difficult. In addition, an aggressive national industrial policy that aims at protecting strategic industries and promoting national champions has built up novel pressures on foreign investors who had once benefited handsomely from their market presence, or even sectoral dominance, in China. Without a doubt, China’s economy has entered a new stage of development. Lower long-term growth rates and painful restructuring are likely to render trade and investment relations less lucrative in many branches of the economy. Yet due to both its huge size and its continuing above-average growth, the Chinese market will remain irreplaceable for foreign businesses in the foreseeable future.

All this poses a fundamental gravitational dilemma for diplomatic and economic relations with China: Even as diplomats and firms see growing risks and seek to diversify their activities away from China, they will not be able to detach themselves from it.

Berlin’s Catalytic Role in EU-China Affairs

Germany’s China policy will need to develop a creative response to this gravitational dilemma. It must adapt to the shifting conditions in China’s development and critically assess traditional goals and priorities.

Germany’s central objectives in dealing with Beijing have traditionally consisted in: supporting China’s integration into the structure of established international institutions and organizations shaped by the West; promoting domestic economic and political liberalization by engaging China in intense business and diplomatic exchanges; and securing the economic interests of Germany as a global trading power in the Chinese market, particularly by taking a stand for open market access and effective protection of intellectual property.

All three goals are being challenged in the current shifting geopolitical and geoeconomic environment.

First, through the establishment of novel China-sponsored international organizations and funding schemes, China is attempting to create governance alternatives to traditional Western-dominated institutions and to reshape global patterns of interaction, especially on the South-South axis.

Second, neither rapid economic-technological development nor intensive transnational and bilateral exchanges with the West have fostered domestic liberalization within China to the expected degree. On the contrary, we are currently witnessing a hardening of China’s foreign and domestic policy stances.

Third, China policy will need to change alongside the shifting fundamentals of economic relations. Key challenges include increased competition from Chinese companies (within China and globally), a risky overdependence of major German industries (cars, machinery) on the Chinese market, a potential loss of traditional advantages in major industrial technologies (mid-tech machinery as well as energy and environmental technologies), and novel patterns of Chinese outbound investments and Chinese business within Europe itself.

These challenges are serious. They do not, however, necessitate a sweeping negation of traditional goals and principles, but rather an adjustment of expectations and policies. German China policy must hold onto overarching principles such as human rights, the rule of law, open markets, and environmental sustainability. However, every inch of progress down this road will be much more difficult than previously assumed and slowed by recurrent setbacks. Expectations must be adjusted accordingly.

More importantly, Germany and Europe should have a clear understanding of their limited capabilities: The traditional, rather self-absorbed ambition to transform China into a European-style democracy through outside advice is unrealistic and should be banished from the policy agenda. China’s political modernization will be brought about by Chinese themselves. It will be based on trajectories and institutions that diverge profoundly from Western historical experience. Neither Americans nor Europeans will be able to provide magic recipes paving the way for democracy in China.

EU China Policies Remain Uncoordinated

With a view to the severe limitations of European China policy, German foreign policymaking needs a sobering reality check. With the notable exception of trade relations, chances for effective coordination of the EU’s China policies are extremely slim. Despite the issuance of numerous EU strategy documents, all previous attempts to develop a joint and comprehensive European approach toward China have resulted in repetitive declarations of intent and poorly coordinated dialogue mechanisms.

Such weakly coordinated and haphazard interactions with China are not just a feature of EU-level China policy. Weak capacities and recurrent disruptions of the foreign policy set-up also constrain the China policies of many individual EU member states, which lack either the standing or the resources to pursue their interests and priorities vis-à-vis China in a consistent manner.

In order to avoid across-the-board stagnation of European China policy, Germany must act as a catalyst on substantive issues. Berlin has both the standing with Beijing as well as the capacity and continuity within its national foreign policy community, to take the initiative and make consistent efforts to expand diplomatic, legal, and social interactions with China beyond trade and technology cooperation. As soon as Brussels gains the capacity to devise viable coordinated China policies, Germany’s bilateral initiatives can be integrated into EU mechanisms. For the time being, however, Berlin is the only European government that can work to keep channels of communication with Beijing open in the most contentious areas of China policy, such as market access, industrial espionage, the Law of the Sea treaty, or modernization of China’s legal system.

Identifying New Areas for Cooperation

There is both great potential and great necessity for new formats of political, economic, financial, and technological cooperation. As China’s economy and society keep developing, Chinese demand for German expertise has increased, especially in the areas of sustainable urbanization, spatial planning, water management, health services, medical technology, and the management of welfare organizations.

On the global level, none of the great challenges of the 21st century – from international and transnational security threats, obstructions to free trade, financial market regulation, or the establishment of a cyber regime – can be effectively addressed without a place for China at the table.

China’s new regional cooperation schemes, especially in Central Asia, require careful examination by European decision makers. Europe could benefit considerably from the establishment of new Eurasian transportation corridors and the economic mobilization of Central Asian societies. Germany should cautiously support China’s endeavors in Central Asia on a project-by-project trial basis by bringing those German and European infrastructure and energy programs into play that have been pursued with limited results during the past two decades but which may now be reinvigorated through joint projects with China.

Germany should also consider becoming involved – albeit cautiously – in individual parallel structures China is currently building and mirror the functions of traditional frameworks such as the Bretton Woods institutions (World Bank, IMF). For instance, German diplomats should consider taking an active part in the newly established Asian Infrastructure Investment Bank (AIIB), in spite of American diplomatic efforts to keep allies such as Australia, South Korea, and Germany away from the Chinese initiative. AIIB responds to massive investment needs in large parts of Asia that have been only partially addressed so far by the World Bank or the Asian Development Bank, and it may open up new diplomatic and business channels in the supported countries.

Building Up Constructive Leverage

In economic relations – which may become a lot more competitive in the future due to intensifying competition and aggressive industrial policies on the Chinese side – Germany urgently needs to build its leverage vis-à-vis China. On the European level, the ongoing negotiations over a bilateral investment agreement with China, as well as China’s wish to establish a full-scale Sino-European free trade zone in the longer term, offer Europe new opportunities to negotiate with China on equal footing.

Negotiations over the EU-China bilateral investment agreement provide a major opportunity for Brussels and Berlin to push for thorough improvements regarding market access, non-discrimination of foreign companies, competitive public procurement, and the protection of intellectual property rights. At the very least, European policymakers must insist on the consistent implementation of all WTO rules in China, including those on public procurement China has yet to acknowledge. As to central conflict-prone trade relations issues such as market access and equal treatment, European and German trade diplomacy must not make concessions but rather push for Chinese commitments in a determined manner.

To reduce the dilemma of overdependence posed by the immense pull of China’s market, German diplomacy and business must work more actively to diversify their political and economic initiatives away from China and toward India and other emerging economies. If only a handful of prospering Special Economic Zones could be established in India with the help of Western investment and know-how, the promotion of economic counterweights against one-sided gravitation toward China would become much more credible.

For cultivating a fallback position in the case of open conflict with China over diplomatic or security issues, Berlin would be well advised to strengthen the existing, sporadically-used communication channels between American and German diplomats and researchers who work on China affairs. If open disruptions occur in interactions with China, transatlantic coordination will be an indispensable back-up for a stronger joint position vis-à-vis China. At the same time, Germany and Europe must avoid being dragged into the intensifying great power rivalries between China and the US that obstruct a core European interest: keeping the Asia-Pacific as open as possible for multilateral engagement.

Engaging China Through Niche Diplomacy

Ambitious strategy papers that rest on lofty goals, linear assumptions, and static instruments are not conducive to making foreign policy in the volatile international context of the 21st century. Instead, especially when dealing with the rapidly shifting international role of China, contemporary foreign policy must be versatile in its instruments, yet persistent in its priorities, to maneuver in a profoundly unpredictable environment.

In recent decades, Germany’s foreign policy approach toward East Asia has met this requirement by focusing on niches within markets and between competing powers in the Asia-Pacific. German diplomacy and business have continuously worked to identify specific areas of feasible cooperation so as to keep exchanges with China open in as many niches as possible.

This niche diplomacy results from decades of diplomatic and business practice, not from a publicly formulated or coherently pursued strategy. Though several official papers on Asia policy have been issued by German government bodies since the 1990s, the practical implementation of policy remained incremental and cautious, yet nevertheless remarkably agile. Niche diplomacy sets its sights on limited areas of cooperation one by one, rather than submitting all policy fields to one grand strategy. This down-to-earth approach to China policy must not be written off as mere opportunism. Rather, it is a means of creating space for cooperation that would remain closed if pursued with more aggressive tactics. Niche policies have been a pertinent approach to working with China on the nuts and bolts of economic cooperation while also addressing controversial issues such as legal and judicial exchanges that contributed, for example, to major (yet inadequately implemented) reforms in China’s criminal procedure laws.

One crucial aspect of niche diplomacy concerns the question of linkage politics. In contrast to what the German public might expect, foreign policy will benefit in many areas over the long term if successful cooperation in one specific niche is not taken hostage by other niches. Thus, even if there may be occasional public calls to link trade with human rights or tie investment to environmental standards, successful niche policy will need to make sure that conflicts or even collapses in one niche do not damage or undo activities in other fields of cooperation. Niche policy can thus cultivate a framework of selective cooperation that is compatible with Germany’s capacities and priorities.

The feasibility of niche diplomacy vis-à-vis China rests on the foundation that industrial and technological cooperation with Germany has proven highly useful in the eyes of Chinese policymakers. This very foundation may be gone as soon as Germany loses its competitive edge in helping China’s industrial ambitions. So far, however, niche policy has opened up many channels in bilateral relations that go beyond trade and investment and today include administrative, legal, environmental, and cultural and educational exchanges. Silently, Germany has also been able to avoid being drawn into intensifying Sino-American rivalries. At the moment German China policy is moving to open up new important niches with many potential bilateral benefits, such as exchanges on fiscal policy or social insurance management. Thus, niche diplomacy continues to provide policymakers with the room to maneuver even through a turbulent international environment while reducing the risks and the costs in broadening exchanges with China.

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