Coping With a Nuclear North Korea
North Korea became the center of gravity in the Asia-Pacific region in 2017 as it passed the year with 16 missile tests and the underground detonation of a nuclear device. There will be no difference in 2018 as Pyongyang tests its weapons' re-entry and guidance capabilities, launches missile salvos over Japan, considers testing intercontinental ballistic missiles near their maximum range or conducts an atmospheric nuclear test over the Pacific Ocean. Though estimates vary, many experts predict that North Korea will achieve a viable nuclear deterrent in 2018.
Within this tight window, the United States will have to decide whether to curb North Korea's nuclear capabilities by force or manage them through a strategy of deterrence. This weighty decision will be at the forefront of global leaders' minds next year, ultimately resting with U.S. President Donald Trump and his advisers.
The first (and less likely) scenario of crippling Pyongyang's nuclear program would require a preventive military strike. Should the United States choose this course, North Korea's response would have devastating consequences, including a massive disruption to regional trade that would heavily damage the electronics, automotive and appliances industries and send shockwaves throughout the global economy. South Korea would bear the brunt of North Korea's retaliation, though Japan may suffer attacks as well. China, meanwhile, would have to decide whether to intervene on the Korean Peninsula to secure a territorial buffer on its doorstep and to stem the outflow of refugees that would likely ensue — raising the specter of confrontation between it and the United States.
If Washington begins leaning toward a military strike, several signs will warn of its coming. First, the United States will pull out all the stops in its campaign to pressure Pyongyang into cooperation, perhaps even leveling harsh sanctions on some of China's core financial institutions and economic entities that do business with North Korea. These measures would come at a time when China is already undertaking a difficult overhaul of its economy, creating economic fallout in and beyond the region.
Second, the United States and its Asian allies would begin moving their military hardware. Washington would order the long-term deployment of two or three carrier battle groups to the waters around the Korean Peninsula; regional intelligence, reconnaissance and surveillance assets would increase; land-based air power, such as stealth fighters, would relocate nearby; submarine deployments would become more frequent; and South Korean troops and reserves would mobilize. Of course, the absence of any or all of these developments wouldn't rule out a preventive strike, since the United States is capable of launching a limited attack on North Korea with its existing presence in the Asia-Pacific. Moreover, an attempt to shoot down a North Korean missile, successful or not, could spark a war.
Barring the unlikely event of a coup in Pyongyang, any measures short of military action won't sway North Korea from its path toward a credible nuclear deterrent. Despite agreeing to a severe U.N. sanctions package against the country in 2017, neither China nor Russia wants the North Korean government to collapse. As a result, they will avoid any action that jeopardizes its stability unless they believe the measures would forestall a strike by the U.S. military. Even if the international community deepens its sanctions regime to an oil embargo or trade ban, North Korea has many tools at its disposal for insulating its leaders and achieving its not-so-distant nuclear goals.
Given the massive costs that a military strike against North Korea would carry, as well as the short time frame in which it must be executed, the United States is more likely to choose its second option: containment and deterrence. The former might entail the economic isolation of the North Korean government, with the intent of limiting the growth of its nuclear arsenal. The latter would involve the gradual buildup of ballistic missile defenses, the permanent monitoring of North Korean activities and the compression of military decision-making channels among the United States and its allies.
Still, a strategy of deterrence carries its own long-term risks, including a heightened threat of miscalculation, similar buildups by Russia and China, and the nuclearization of South Korea and Japan. Furthermore, the fortification of a U.S.-aligned defense infrastructure around North Korea could undermine the missile architecture of Russia and China, bringing their mutual interests further in line, just as the deployment of the U.S. Terminal High-Altitude Area Defense system to South Korea has.
As tension mounts on the Korean Peninsula, the United States will work to renew the resolve of its most important regional allies. Over the past year, its ties with South Korea and Japan have strengthened. Though Seoul firmly opposes the idea of a preventive military strike against Pyongyang, neither it nor Tokyo would be able to stop Washington from launching one. Even if the United States rejects that route, a pre-emptive strike meant to interrupt an impending North Korean attack would still be on the table.
China in Transition
If the unlikely possibility of war on the Korean Peninsula comes to pass, it would have a devastating effect on the political and economic stability that China has worked for the past three decades to preserve. But beyond the potential crisis brewing next door, China has no shortage of internal challenges to address as it enters a new political and economic era. In many ways, Chinese President Xi Jinping's consolidation of power over the past five years is the result of the country's transformation over the past 30 years as the ruling Communist Party has struggled to weather the profound domestic and international challenges it faces. As Xi starts his second term, maintaining his unrivaled authority will be imperative, particularly as a critical period of China's ongoing restructuring begins.
Xi's newly amassed power will help him marshal the resources and forces he needs to advance his vision for China. This future calls for the substantial redistribution of wealth; greater socio-economic equality; a stronger Party, state and military apparatus; and the projection of power to match the country's rising influence worldwide. Each of these goals is difficult to implement and is made up of many equally daunting objectives that require the ability to push tough reforms through many different interest groups. However, the close coordination of policy within a robust Party and state structure will remove some of the obstacles ahead of Xi, paving the way for the more challenging and politically sensitive reforms as he deems necessary.
Xi's tight grip on power will also create high expectations, though, leaving him little room to guard against policy inefficiencies or failures. Here the Communist Party's ability to keep demonstrating its commitment to identifying and punishing the misdeeds of government officials and institutions is key. The Party will establish an anti-corruption supervisory body, the National Supervision Commission, in March. The new organization will lend additional momentum, enforcement and oversight to the campaign against graft that has underpinned Xi's political agenda and ability to sideline opponents. But it may also fuel concerns about the abuse of power, particularly at the local level. As Beijing feels more compelled to defend its authority, it will rely on political and ideological conformity, the control of the media or the suppression of dissidents to enforce its official line, risking backlash in the process.
Next year Xi's agenda will center on the challenging socio-economic issues plaguing China. The economy's growth is slowing, compounding the country's substantial regional and social inequality, distorted financial systems and severe environmental degradation. After several years of gradual progress, the Communist Party will look to speed the pace of reform ahead — testing its ability to shore up legitimacy as the economy loses steam. With an eye toward the redistribution of wealth, Xi will accelerate fiscal reforms in 2018, channeling more money to underdeveloped regions and bolstering the financial base of local governments. At the same time, China will keep taking steps to improve social welfare as reforms to land policies and the hukou system of household registration take shape.
Despite its eagerness to push ahead with its plans, Beijing will proceed with some caution to make sure that the rapid rate of reform doesn't endanger social stability. To that end, fiscal proposals will focus on issues that aren't politically sensitive, such as the implementation of environmental taxes, an uptick in resource taxation and the reduction of taxes for small businesses and individuals. Though China may also take steps toward imposing a property tax, the country's highly leveraged real estate market could delay any attempts to enact the measure nationwide. Nevertheless, the public's expectations of the government's efficacy will ramp up alongside its effort to contain soaring property prices, especially in large cities.
China likewise will keep in place production cuts in heavy industries like coal and steel while trying to deleverage those sectors. At the same time, it will more closely enforce environmental regulations. But it will do so only to the extent that these efforts don't seriously disrupt employment and stability, particularly when it comes to shutting down the country's struggling zombie corporations, or state-owned enterprises operating at a loss. Beijing's attempt to tackle inefficiency in the heavy industries may put upward pressure on the prices of commodities like coal and steel, offsetting slowing investment. If commodity prices rise, the government would have more leeway with the public to hasten its campaign.
Ensuring financial stability will be at the top of Xi's economic agenda. China's mountain of debt will grow steadily higher over the next four years, climbing from 251 percent of the country's GDP today to as much as 320 percent by 2022. However, throughout 2017, Beijing worked to reduce the country's most dangerous debt burdens and pre-empt the risks posed by the rest. It also offered debt-for-equity swaps and private capital to state-owned enterprises, reinforced oversight mechanisms, closed legal loopholes on shadow lending and tightened real estate regulations in major metropolises.
China will feel the benefits of these measures in 2018, but they won't guarantee the country a stable financial future. The new year will bring new sources of strain as high maturity rates are applied to overlapping corporate and local debts for the next three years. At the same time, the creation of credit and the Chinese real estate market appear likely to stall. Stress in the real estate sector, which will account for half of China's corporate debt maturity in 2018, could in turn carry substantial risks: Not only would a meltdown in the market trigger a series of corporate defaults, but it would also put considerable pressure on the country's financial system.
China has the fiscal and regulatory tools to avoid this scenario, at least on a national scale. However, a localized debt crisis or collapse in the real estate market cannot be ruled out, especially in the vulnerable and heavily indebted areas of the northeastern rust belt, central provinces and heavy industries such as construction, utilities and steel. At best, a contained catastrophe would detract from China's ability to maintain its economic growth and pursue difficult reforms; at worst, it could result in local corporate defaults, bankruptcies and even popular discontent.
As China seeks to address its economic problems at home, several factors beyond its borders will help determine its success. Assuming war does not break out on the Korean Peninsula, China will find much-needed buyers for its exports in the steady economies of Europe and the United States. This relief will be particularly well-timed, considering China's investments in fixed assets — a cornerstone of its economy — will continue to slow next year.
On a less positive note, 2018 will bring the real possibility of heightened tension with the United States in trade as the White House more strictly enforces regulations. China will be one of its primary targets, which — along with the protectionism spreading worldwide — could put pressure on the Chinese economy. Over the past year, U.S. trade measures against China have been largely confined to anti-dumping action; next year they will likely be broader. Even so, both powers will manage their dispute enough to prevent it from escalating into a full-blown trade war.
The United States has erected trade, investment and intellectual property barriers against China for quite some time. However, Trump has wielded these tools more aggressively than many of his predecessors. Combined with his administration's skepticism of multilateral trade mechanisms and determination to reduce the U.S. trade deficit, this approach has encouraged the White House to forgo the use of the World Trade Organization (WTO) to settle trade disputes where possible.
The United States used this year to lay the groundwork for a two-pronged offensive against China. First, it opened an investigation into Chinese intellectual property practices under Section 301 of the Trade Act of 1974. Second, it began to scrutinize national security concerns related to the steel industry under Section 232 of the Trade Expansion Act of 1962. Both of these developments will come to a head in the next 12 to 18 months. On matters covered by the rules of the WTO, the United States will challenge China's intellectual property practices through the organization. More often, however, it will target Beijing's behavior beyond the WTO's bounds. The White House may focus on the sectors it explicitly mentioned in its trade strategy, including heavy industries like steel, automotive and some electronics. Washington will also enter into negotiations with Beijing to persuade it to ease certain trade and investment barriers. Meanwhile, the United States could pursue additional action against Chinese steel and aluminum under the auspices of its national security review. Divisions within the Trump administration might limit the use of this option, though, especially as China keeps slashing production in both industries.
For its part, China will answer by bringing cases to the WTO in hopes of responding with measures sanctioned by the organization. But to hedge its bets, China will also build out its own intellectual property protections — safeguards it increasingly has use for as its companies pump out higher-value products. In addition, Beijing will use the promise of easing its technological transfer requirements or opening up its financial, services and renewable energy-fueled vehicle markets to dissuade Washington from applying more pressure to the Chinese economy.
Though Xi has vowed to open up China's markets before, foreign investors have been dissatisfied with the lack of progress during his first five-year term in office. The Chinese state's steady consolidation of economic power has only added to their frustration. That said, as Xi and the Party achieve the level of control they seek, they may resume many of their long-delayed reforms. To that end, Beijing will test the waters of market liberalization by creating more room for foreign investment in pilot regions like the Shanghai free trade zone. But China will proceed only insofar as these projects align with its overarching strategy, ensuring that they won't be drastic enough to deter punitive trade measures by the United States.
In fact, under its Made in China 2025 initiative, China has dramatically expanded the role of the state in corporate investments into strategic sectors overseas, such as semiconductors and artificial intelligence, for the past three years. Such moves will keep causing concern in developed markets like the European Union and the United States as the competition heats up in high-end markets and accusations of unfair Chinese practices abound. Consequently, Western countries will keep a closer eye on Chinese investments into their high-tech industries.
China's persistent quest for market-economy status within the WTO — against the wishes of the United States and the European Union — will be another source of friction. To make matters worse, Beijing has opened cases within the organization against both parties; a verdict on China's dispute with the European Union will likely appear by early 2019. Should the Continental bloc and the United States lose their cases, they probably will remain steadfast in their demands of China. Washington will be particularly reluctant to relent, perhaps forcing Beijing to return to the negotiating table.
Of course, China won't be the only country in the United States' crosshairs. Japan and South Korea have experienced similar pressure from their increasingly protectionist ally as the United States seeks to reduce its trade deficits with them. They, too, have tried to avoid drawing Washington's ire. Tokyo was somewhat successful on this front in 2017, and it will continue to fend off Washington's demands. Seoul, on the other hand, faces the lengthy process of renegotiating its free trade agreement with Washington.
During these talks, the United States will likely push for greater access to South Korea's automobile, electronics and agriculture sectors. At the extreme, Washington may even renounce the pact if it is not satisfied with the results of the talks. Though South Korea has little interest in jeopardizing its relationship with the United States amid the imminent threats emanating from North Korea, any disruption to their trade arrangement will strain the South Korean economy — giving countries like China an opportunity to exploit the rift widening between the two allies.
The premium that Washington has placed on bilateral trade negotiations will only encourage other countries in the Asia-Pacific to seek out multilateral trade platforms that exclude the United States in order to advance their own agendas. The Comprehensive and Progressive Agreement for Trans-Pacific Partnership — a version of the shuttered Trans-Pacific Partnership that the United States does not belong to — still needs to reconcile its members' conflicting opinions and navigate issues surrounding state-owned enterprises, dispute resolution mechanisms and cultural exemptions. But as the deal gradually takes shape, potentially granting Japan a bigger role in setting regional trade policies, China may feel the need to fast-track its own proposal for an economic bloc: the Regional Comprehensive Economic Partnership.
The New Silk Road
As the United States has tried to scale down its commitments abroad, China has seized the chance to expand its own, in part because its ever-growing interests overseas demand a coherent global strategy. Beijing's sprawling Belt and Road Initiative is one means of extending its influence. Despite China's tendency in 2017 to regulate investments that it believes to be irrational — those in the entertainment, real estate and cultural sectors, to name a few — it will steadily funnel money into the Belt and Road Initiative. The government's strategy of helping Chinese firms climb the value chain will facilitate these financial flows. However, its attempts to ease domestic debt burdens may also undermine corporate finances, potentially cutting off funds to projects whose plans or locations carry added risk.
The Belt and Road Initiative is closely intertwined with China's attempt to increase its global outreach as the international system evolves. In some ways, that evolution may help Beijing achieve its goals. Mounting U.S. pressure has brought Russia's interests into closer alignment with China's — in part because both countries share the desire to insulate themselves from U.S. sanctions. Their burgeoning partnership could increase China's access to Central Asia and the Middle East. In the meantime, as the United States adjusts its strategy in Afghanistan, putting further strain on its relationship with Pakistan, China may have an opportunity to cement politically sensitive projects along the China-Pakistan Economic Corridor as Islamabad turns to Beijing for closer security cooperation.
China's endeavors will not always go smoothly, though. When the Shanghai Cooperation Organization summit convenes in China in June, Beijing will try to expand the bloc's agenda on economic and infrastructure initiatives. But the move will likely encounter resistance from India, which has opposed the Belt and Road Initiative as it has watched China's growing assertiveness in the region with trepidation. In fact, Beijing's ambitions will spur New Delhi to team up with China's regional rivals, including Japan, to advance competing infrastructure projects in Southeast Asia and Africa and to increase security cooperation. At the same time, political instability, regional groups, local insurgencies, funding problems and suspicions of China's motives will continue to endanger Beijing's connectivity schemes in Central and South Asia.
Closer to home, China will keep relying on a combination of diplomatic pressure and military coercion to curb Taiwan's outreach to other countries, including the United States and its allies. Meanwhile, to the west, Beijing may have a rare opportunity to pursue a dialogue with Tibet's government in exile as the Dalai Lama ages. The path toward negotiation is all but certain, but talks would enable Beijing to limit New Delhi's ability to leverage the Tibet issue as the Sino-Indian rivalry and border dispute intensify.
China's Neighbors Strike a Precarious Balance
Though North Korea's recent activities have drawn the United States' attention to the Asia-Pacific, Washington's engagement in the region will diminish in the long run. China's presence, however, will grow. As a result, countries in the region will try to both work with and counter Beijing, a balance that will come to define the Asia-Pacific in the years ahead.
This year, friction between Beijing and Seoul worsened over the deployment of U.S. Terminal High-Altitude Area Defense missile systems to South Korea, eventually triggering the imposition of economic countermeasures by China. Tension likewise marred China's relationship with Japan as the two sparred over the East China Sea throughout 2017. But toward the end of the year, Beijing's ties with its rivals warmed: China and South Korea normalized relations, while Japan hinted that it might participate in China's Belt and Road Initiative. Next year may even bring a trilateral summit for the three neighbors — a gathering that has been suspended since 2015 because of their quarrels. This hardly means their contest for regional dominance will subside. There is, however, room for the North Korean threat, mutual economic interests and the United States' drift away from its current alliances to erode their enmity for one another.
The easing of tension in Northeast Asia won't preclude the formation of coalitions intended to contain China. Chief among them is the U.S.-led Quadrilateral Security Dialogue, which includes Japan, India and Australia. As new formats evolve, the powers interested in curbing China's reach will try to settle their internal differences as their security cooperation deepens. Australia will serve as a key swing state because of its strong trade relationship with China and domestic controversy stemming from those ties. By contrast, Japan and India will form a sturdy front against China. By no means does the bloc portend a formal security alliance — or even alignment — among members, but its loose agenda could appeal to countries with a mutual interest in containing Beijing, such as Singapore and Vietnam. China, for its part, will approach individual countries in an attempt to dilute the coalition coalescing against it.
China will use a similar strategy to take advantage of the United States' distraction with North Korea. Beijing will redouble its efforts to reach out to claimants in the South China Sea, offering compromises that reflect its pre-eminent position in the disputed waterway. This year, China achieved several diplomatic victories with this tactic, including progress on drafting a nonbinding code of conduct in the South China Sea with the Association of Southeast Asian Nations (ASEAN). Beijing will use next year's negotiations over the deal to showcase its success — and to discourage interference by external powers. Though U.S. operations in the contested waters will continue unabated, China will guard against the United States' attempts to encourage countries like Australia, Japan and India to increase their participation and responsibilities in the region.
China also succeeded in preserving its detente with the Philippines as the two countries took strides toward joint energy exploration and coast guard drills. The Philippines, too, aims to protect its sovereignty over its maritime territory. But Manila's conciliatory approach toward China has freed much-needed capacity to deal with urgent issues at home. Though Philippine forces managed to reclaim Marawi City from the Islamic State this year, political and security problems will continue to plague the country in 2018. The administration of President Rodrigo Duterte will turn its attention to revising the constitution, passing legislation to support its peace deals with Moro rebels, securing the restive region of Mindanao and reining in communist militants. With so many concerns to address at home, the Philipines cannot afford to take a tougher stance against China. And though the Philippines' security relationship with the United States will persist, it will not endanger the country's budding cooperation with China.
China's ties with the other major claimant in the South China Sea — Vietnam — are not so friendly. Over the past year, the two countries canceled military meetings, Beijing pressured Hanoi to halt energy exploration activities in the sea, and the United States announced plans for an aircraft carrier visit to Vietnam in 2018 — the first since the end of the Vietnam War. Though national debt and economic reforms will top Hanoi's agenda in 2018, Vietnam is more stable than the Philippines and will have more space to try to counterbalance China. Just as it did in 2017, Vietnam will try to draw other countries such as Japan, India, Russia and the United States into the South China Sea.
ASEAN will not have the same clarity in its dealings with China. Instead the bloc will face numerous obstacles as it tries to navigate the Chinese-U.S. rivalry in the region, terrorist threats and economic uncertainty. This year, disunity rose within the bloc as some of its members, including the Philippines, struck out on their own to form policies toward China. Such discord will only worsen in 2018 as member states cope with problems at home. For instance, the popularity of the governments in Cambodia, Malaysia, Indonesia and perhaps Thailand will be put to the test in national or local elections next year.
A Japanese Awakening
As a crisis of nuclear proportions brews on the Korean Peninsula, it will spur Japan ever onward in normalizing its military by bolstering its missile defenses and exercising the enhanced powers outlined in security legislation passed in 2015. The ruling Liberal Democratic Party will also use the popular mandate it received after it swept elections in late 2017 to forge ahead with its agenda for constitutional reform. However, the party likely won't meet the ambitious timetable that Prime Minister Shinzo Abe laid out in mid-2017 as it works to avoid a dip in public opinion. Moreover, Abe's administration will spend next year trying to contain corruption scandals and internal jockeying ahead of a transition in party leadership in late 2018. The commotion could sap legislative resources and undermine the prime minister's popularity. Still, Japan will enter into the new year with seven consecutive quarters of economic growth under its belt, thanks in large part to rising global demand and Tokyo's stimulus measures. This feat could finance further economic reforms, particularly those that center on wages, income taxes and labor laws.
As the North Korean crisis and a mutual interest in countering the West pull China and Russia closer together, Japan will seek better ties with both. On some level, Tokyo may work with Beijing on its Belt and Road Initiative. Meanwhile, Japan will move forward with economic cooperation with Russia in the Kuril Islands in pursuit of a peace treaty to officially end their World War II-era hostilities and resolve territorial disputes. All the while, Tokyo will work with Washington to try to pressure Pyongyang to change its behavior.
Editor's Note: We have updated this piece to correct information about the planned timing of a U.S. aircraft carrier's visit to Vietnam.