The Geo-Political Tensions between the US-China: ASEAN caught in the middle, the future of the Japan and ASEAN cooperation and the prospects of semiconductor supply chains

Bilahari KAUSIKAN: Three fundamental factors about China profoundly influence the issues that are the topic of today's talk. First, China is a communist country, not in ideology, but in its political structure. It is a Leninist state, and the Chinese Communist Party claims a monopoly of power over every aspect of the state and society. Everything is subordinated to the interests of the Party and its control, which is of the highest value in a Leninist state, with no compromise; only tactical adjustments. Reform in a communist state always strengthens the rule of the Communist Party. Reform that could threaten Chinese Communist Party rule is impossible. Mr. Xi Jinping has stressed party control, party discipline and the leading role of the party in China is the achievement of its ambitions.

The second fundamental factor about China is that it is a civilizational state whose current form is the People's Republic of China, led by the Communist Party. In the Chinese Communist Party's version of Chinese history, the People's Republic of China is China and Chinese civilization has been redeemed by its leadership after a long period of weakness. For example, the South China Sea and the Senkaku Islands are important to China because they are inextricably bound up with a nationalist historical narrative of humiliation and ultimate rejuvenation and the realization of the Chinese dream under the Chinese Communist Party's leadership. This narrative is vital because it legitimizes the Chinese Communist Party's right to rule. Also, claims about other parts of China that it claims were lost—for example, Siberia or Korea—would be too politically costly. The Communist Party justifies its right to rule only by making claims in the South China Sea and Senkakus precisely because they are so insignificant; they can do so without too much risk.

Mr. Xi did not invent this narrative, although he emphasizes it to a greater degree than all his predecessors. Mao Zedong used it as did Chiang Kai-Shek. The quest to regain the wealth and power that was lost when China was weak has motivated different types of political systems in China since contact with the West. This narrative is powerful and attractive to Chinese citizens and some overseas Chinese because it is largely true. The West and Japan did in fact take much from China in the 19th and 20th Centuries. Chinese nationalism as defined by the Communist Party is based on revanchism: the recovery of lost territory and the international acceptance of a hierarchy with China at its apex. Because this narrative is connected to the legitimacy of Chinese Communist Party rule, on this narrative and its territorial implications, there can be only tactical adjustments, and no fundamental compromise. This has profound consequences for China's relations with the U.S., Japan, India and the countries of South East Asia, among others.

The third fundamental factor about China is a subtler point than the other two. Sociologist Fei Xiaotong explained the essential differences between Western and Chinese society by reference to the rural foundations of Chinese society. This, in his analysis, led to the greater immediacy and importance of family and local networks, of personal relationships centered on themselves rather than on the institutions of the state. Fei argued Chinese society has a deeply ingrained, "self-centered quality" and that traditional Chinese society was selfish. These selfish personal networks challenge a Leninist party's basic principle of centralized rule and its claim to a monopoly on power and authority. The Chinese Communist Party has continually struggled to transform this deeper social structure into something more collective. To do so, it has turned to a variety of ideologies, lately even Confucianism, which the Party had once cast aside. This speaks to the intractableness of the problem the party faces in the transforming the insular nature of Chinese culture. Xi's "socialism with Chinese characteristics for a new era" is the latest attempt to assert the kind of impersonal and collective identity the Chinese Communist Party wants to promote.

These three factors account for both China's strengths and its weaknesses. The centralized and largely unaccountable power of a Leninist state buttressed by a popular nationalist narrative gives it the ability to make fundamental decisions and pursue them relentlessly with minimal long-term internal dissension. The ability to act decisively and over the long term is a great strength but only if a decision is correct. If the decision is incorrect, the great strength can become a great weakness. Deng Xiaoping's decision to reform and open up was correct, but Mao's decisions that led to the Great Leap Forward and the Cultural Revolution were catastrophic disasters.

Comparing Xi Jinping and Mao Zedong is inappropriate, but there is one similarity. By concentrating power in himself, Mr. Xi may have reintroduced a Maoist single point of failure into the Chinese system: a single decision-making point with minimal room for alternative views, whereby a single bad decision can have a system-wide effect. This is particularly so because there is reason to wonder about the quality of the information that the leadership gets in a system where the cost of dissent or perceived dissent has been raised by Mr. Xi.

I think such a misjudgment is responsible for the current state of U.S.-China relations. The initial mistake probably began towards the end of the Hu Jintao years after the global financial crisis. At that time, China seemed to have begun to believe its own propaganda about the U.S. being in inevitable decline. China may have taken the Obama administration's reluctance to exercise power as a new norm in American foreign policy. Mr. Xi doubled down on these mistakes. Mr. Xi's signature Belt and Road Initiative and the Made in China 2025 plan flaunted China's ambitions and in effect repudiated Den Xiaoping's strategy of quiet planning and execution.

Mr. Xi's exposure of China's ambitions is a major factor in its relations with the US and other Western and advanced economies. The nascent coalition of countries with concerns about China or certain aspects of Chinese behavior was created not by the U.S. but by China itself. This is a remarkable failure of Chinese foreign policy. The problem with abandoning the strategy China was pursuing is that it is irreversible: once you reveal your ambitions and intentions, you cannot conceal them again. This was a strategic mistake.

Some of the structural reforms the U.S. has demanded strike at the core of the Chinese Communist Party's grip on power and therefore will not happen. It is impossible for any Chinese business to operate without the favor of the Chinese Communist Party. Business and party officials therefore cultivate networks of mutually beneficial relationships at the local level that create the uneven playing field and the skewed implementation of laws and regulations that foreign businesses complain about. These networks distort the economy but they operate within the selfish social structure that Fei described, making them difficult for the central authorities to overcome, assuming there was such an intention in the first place. There seems to be a fundamental mismatch between incentives at the local level and at the center. Huge countries inevitably generate internal centrifugal forces, but in China's case, they are accentuated by the personal networks that Fei described. This is not a new condition for China nor is it an epiphenomenal condition. It is perhaps a structural condition against which the Chinese polity has struggled for centuries. We should not assume that the central authorities will always see correcting distortions to be in their best interest.

Even if new foreign investment and intellectual property protection legislation is passed, its interpretation and implementation will be subject to the Chinese Communist Party's interests and control. You can never have the rule of law in a Leninist state because the law is subordinate to the party's interests; it's never more than an instrument of the party's will to be used or not used as the party's interests dictate. In a country like Japan or Singapore, the law is above politics. In a Leninist state, the law is an instrument of political will and not a check on it.

We all know that China has made remarkable progress in many areas of technology, but we all also now know that semiconductors have emerged as a serious vulnerability in China's capabilities. You need semiconductors for anything electronic. This is not a problem that can be fixed merely by throwing money at it, which is always China's preferred solution. The choke points in critical technologies and in critical intellectual property are all held by Western powers and other friends and allies of the United States. I'm not arguing that China will never overcome this problem, but it will take a long time and the frontier of progress in this technology is continually moving forward. They're trying to catch up with a moving target. The key factor that will determine the success or failure of China's efforts to plug the semiconductor gap, at least in the short and medium term, will be external. U.S. policy will be the critical factor.

The China semiconductor gap is a serious vulnerability because so many of China's hopes to move up the value chain to the next generation of industries, as well as its military modernization program, depend on it. Narrowing the semiconductor gap will certainly figure prominently in the next five-year plan, and it was already stressed in the Made in China 2025 initiative, but the problem is much older than that. The Chinese government has warned against unqualified industries rushing into the semiconductor industry just to take advantage of the tax and other incentives that the government is offering. A semiconductor company halted its plans, which is just one example of these failures. The semiconductor supply chain is very complex and it's hard to break into it except at the low end of the value chain.

Another perhaps even existential economic issue arising from the Leninist nature of the Chinese state is that China's development is, to quote then-Premiere Wen Jiabao in 2007, "unstable, unbalanced, uncoordinated and ultimately unsustainable." At its 18th party Congress in 2012, the Chinese Communist Party officially acknowledged that the growth model that had brought it spectacular growth in the 1990s and the early 2000s was unsustainable. At the plenum of the 18th Congress in 2013, it announced a plan to restructure the economy with a "decisive role for the market in the allocation of resources." By the time of the 19th party Congress in 2017, implementation of this new approach was still hesitant and patchy. Xi Jinping's speech to the 19th Congress redefined the principal contradiction facing China as that, and I quote, "between unbalanced and inadequate development and the people's ever growing needs for a better life." In other words, rising expectations across a broad range of different policy domains.

China has to generate long-term growth to meet the ever growing expectations of its people or the Chinese Communist Party's nationalist narrative will begin to ring hollow. Now, as I've stressed, China is a Leninist state focused on control not just of politics, but of all the aspects of society. A free market means less control and not just in economics. Appropriate balance between political control and market efficiency is not clear. In a Leninist state, once all the easy reforms have been made, political and economic logic are not easily reconciled.

China faces a vicious cycle. Sustaining growth to meet continuously rising expectations requires greater economic efficiency. Greater economic efficiency will require a new growth model based on a new balance between party control and the market. Establishing that new balance will necessarily entail risk. Mitigating the political risks will require growth to satisfy rising expectations. Sustaining growth will require a new model based on a new balance, and so on. Mr. Xi has so far placed much greater emphasis on party discipline and party control than on market efficiencies. By emphasizing Communist Party control, Mr. Xi has sharpened the difficulty of finding a new balance between political control and market efficiency. He and the party have improvised around this core issue rather than directly confronting it.

It is too early to tell whether an increasingly difficult external environment will be sufficient to compel the CCP leadership to break the vicious circle that I described. So far, the new dual circulation policy's greater emphasis on the domestic economy seems to be nothing new: it prescribes upgrading industry up the value chain, focusing on more productive and less wasteful investment and pursuing greater self-sufficiency in key technologies, including semiconductors, while placing greater emphasis on domestic consumption, urbanization and better environmental protection.

Some of these objectives have their own internal contradictions. For example, China has been trying to increase consumption as a percentage of GDP for a long time with limited success. Domestic consumption is 38% or 39%; below average for an economy of China's size and well below that of the U.S., the Eurozone and Japan. It is 56% in Japan. To raise domestic consumption, you have to reduce the propensity to save, which requires better social security nets, better quality and more affordable healthcare and housing and other provisions for a rapidly aging society. That brings me back to the previously mentioned vicious cycle. All this requires more resources, a new growth model and so on. It also requires a more serious effort than we have seen to free China from its addiction to the infrastructure investment at home and abroad that has characterized China's economic policies. All these efforts have been heightened by the U.S.-China rivalry and the consequences of COVID-19.

China wants to reduce carbon levels but it is burning more coal than ever in order to promote growth during and after the pandemic. It needs to deleverage and it was doing so but it now also needs to stimulate the economy. Many measures seem to be accounting tricks rather than real solutions. To deal with the debt problem and property bubbles, you need land and tax reforms but this has not yet happened. Recently, there have been a number of high-profile bond defaults and I expect more. The real test of whether the Chinese government is prepared to deal with the moral hazard problems will come when a major SOE is at major risk of default.

Nothing I have said is meant to suggest that China or the CCP is going to collapse or fail and we should not wish it to. While a successful and assertive China poses us with serious challenges, a failed and resentful China would cause even more problems. What I am pointing out is that China is a country like any other. Our strategic choices may be distorted to our disadvantage if we don't see the country as a whole, both with the country's strengths and its weaknesses.

The Biden administration is not expected to change direction on China but its policymaking will be more orderly and transparent. I don't think Biden will lift the present tariffs on China but he might slowly ease their implementation. He will focus on domestic policy, including the response to COVID-19. Biden needs the cooperation of Republicans in Congress and will not unnecessarily create strife.

Almost all semiconductor suppliers are in America or among America's allies. Biden may be more generous in granting licenses than Trump, but will Biden put American companies first in terms of granting licenses? The choice of who will get exemptions or licenses for what equipment or components will be essentially political. There will be furious lobbying in Washington, DC. My advice to Japanese companies who hope to benefit from this lobbying process is to start now.

Some ASEAN countries thought the U.S.-China conflict would lead to relocation of production to Southeast Asia. Some relocation has happened but largely at the low end of the value chain. I think this shift will to some degree continue, but ASEAN should not expect this shift to be automatic at the high end of the value chain. Shifting out of China will be difficult because of the supportive ecosystems that have developed in China for many industries. ASEAN has to develop to match those ecosystems. Also, China is not a country that any industry can ignore no matter what the industry. ASEAN needs to move more quickly to have a chance to attract those entities that would move out of China. Common rules of origin in the RCEP may help. For the high end of the value chain, technological industries in particular, security considerations will still apply whether the industry is located in Southeast Asia or in China. This is particularly true in the semiconductor supply chain. I don't see these companies moving to Southeast Asia. What Biden does can have only a limited impact here.

How the digitalization of global supply chains and the so-called fourth industrial revolution will affect ASEAN is an interesting question. New technologies like AI and 3D printing seem to be eroding the cost advantages of widely distributed supply chains. Along with political and security-related pressures for reshoring, this jeopardizes ASEAN's plans to make Southeast Asia a common production platform. Singapore and other countries became successful by following Japan's lead up the supply chain. Countries may find themselves stuck in the low end of the value chain if the supply chain itself is fundamentally disrupted by new technologies. The effect of this on the stability of Southeast Asia is uncertain.

Geopolitically speaking, the essential problem for the new Biden administration is that Trump was not all bad and Obama was not all good. This caused China to misunderstand the U.S. and problems in the rest of Asia, and Biden needs to take ownership of this. I hope that Japan can advise them. Biden's administration needs to realize that every move it makes will be over-scrutinized. Who Biden nominates will also be crucial. I hope the team will not overcompensate for the Trump years. One of the most important things the Biden administration can do to reassure Southeast Asia and indeed the entire Indo-Pacific is to re-engage with the CP/TPP. Unfortunately, I don't think this is likely until after the midterm elections and even then it is unknown whether the U.S. will do so.

Commentator: I'd like to briefly comment on the value of ASEAN from Japan's perspective. The ASEAN countries occupy a significant position in the global value chain in the machinery industry right now but when it comes to digital products, it's a totally different scenario.

The concept of trade is always goods and services, but we have to think about data flow also. The flow of data in and out of China vastly exceeds the U.S. According to the Nikkei, China now accounts for 23% of cross-border global data; twice the share of the U.S. The U.S. accounted for 40% of the data flowing in and out of China in 2001, but that has dropped to just 25%. Other Asian and Southeast Asian countries now make up more than half, particularly Vietnam and Singapore, which means data flows between China and Southeast Asia have greatly increased.

The source of Beijing's power in the region is its connection with Southeast Asia, and when China becomes a global data superpower, it will control a vast resource that is very valuable to economic competitiveness. The sources of economic competitiveness are not just raw materials and technology but also data and other intangible economic assets. Data from foreign sources can provide a competitive edge in the development of AI, because the more and better data an entity can collect, the smarter the AI they can develop. Of course, hardware is also critical and fundamental to this process, as the ambassador mentioned, and here semiconductors are the key.

The semiconductor market in actual devices is large and the U.S. occupies about 50 percent of it. Three major companies make semiconductor design software and 90 percent of this market is dominated by the U.S. Japan still holds the majority of the wafer production market with 57% and our best-known company in wafer production is Shin-Etsu Kagaku. Foundries are also quite important and represent a choke point in the entire production chain, and here Taiwan's TSMC is a superpower. The second largest foundry is in Taiwan as well and Taiwan overall has 71% of this market. Packaging and testing facilities are mostly located in Taiwan, with 54%, although they have some factories in China. The final component is equipment, which represents another choke point. Manufacturing semiconductors requires top-notch equipment which is produced by the U.S., such as Applied Materials and others, and the Japanese, Tokyo Electron and others. The U.S. still occupies most of the value chain and its hold is actually growing, with Japan losing ground.

Taiwan, however, is a superpower in this supply chain, which is why the Trump administration was pressuring TSMC to set up a factory in Arizona. China doesn't want this. TSMC is caught between the U.S. and China but it has no choice but to follow the U.S. Of course the situation with Taiwan is a serious concern, especially after what happened in Hong Kong this year. Strategically and economically, it is a very important partner, but it has been neglected in trade deals. Japan, the U.S. and other major nations lack free trade agreements with Taiwan, and this is where Singapore has been smart in establishing such an agreement.

Despite the likely continuation of U.S.-China tensions even with the new Biden administration, I believe that a stronger relationship between Japan and ASEAN can promote stability in the region. China wants to hoist its flag in ASEAN and Japan thinks of itself as ASEAN's best friend. The EU has encouraged the region to adopt its economic legal system and national technical standards certification, bringing most ASEAN nations under the influence of the EU system. The U.S. has become aware that its needs to have a strong presence in the region to counter China. ASEAN popularity means that everyone has to be creative when it comes to policy while in the midst of this U.S.-China conflict.

Ahead of the incoming Biden administration, the Suga government is hurriedly restructuring its foreign policy. China is moving to establish a new relationship with Japan. My question to the ambassador is: what should we do? How can ASEAN move up into the high end of the value chain and build a new value chain with Japan?

KAUSIKAN Bilahari: Individual ASEAN members will have to improve their own economies first as economic conditions are very uneven in ASEAN. Common rules of origin can help trade flows. To encourage digital flows, we have to improve conditions in our own countries, including HR and hard infrastructure.

The U.S. is always going to have a big problem in the Indo-Pacific region because it's an offshore balancer. If an offshore balancer is too assertive, people fear getting entangled in its quarrels. If it is too quiet, people fear being abandoned. Japan has a crucial role in evening out this oscillation between fear of entanglement and fear of abandonment because the U.S.-Japan alliance anchor sthe U.S. in the region.

Moderator: Can you name three specific risks in Asia in the context of the U.S.-China conflict?

KAUSIKAN Bilahari: First, the biggest geopolitical risk is Taiwan. I don't think China is looking for war, but as I mentioned in my opening remarks, this is not a claim that China can ever renounce. They have been more assertive recently. The second risk is in the South China Sea. I don't think it's a very high risk, but the risk of accidents does exist, and the Senkakus are similar. I think that if there's an accident in the Senkakus or in the South China Sea, everybody will try their best to quickly contain the fallout. Taiwan is a different issue. Things could easily get out of hand. The second risk is that unless the U.S. moves quickly to re-establish itself as a multilateral player in trade, we may get locked into path dependencies with China. I don't think the risk is very high because people are aware of it and are trying to find alternatives, but the U.S. is the crucial factor geopolitically and economically.

The third risk is a psychological risk. Competition is both psychological and material. There is a strong strain of Chinese propaganda that is intended to induce fatalism: you have no choice but China. But there is always a choice, so we must not get drawn into this fatalistic frame of mind. The U.S. is not going to leave this region. Its engagement in the region will change and countries like Japan, Australia and India will have to take up some of the slack. The psychological risk is the most intangible, but the most dangerous in a way, because it could cause you to artificially narrow your options.