Two bets are on the table. One has been placed by the Washington establishment, the other by the Chinese Communist Party.

Analyzing China’s prospects in terms of fashionable globalist ideology, Washington is betting that a rich China will be a free one. The theory is that the only way China can continue to grow is by embracing Western democracy and capitalism. Moreover, the very process of China’s enrichment is supposedly undermining the Beijing government’s authoritarianism. More wealth means more freedom means more wealth.

Here is how President George W Bush has put it: “As China reforms its economy, its leaders are finding that once the door to freedom is opened even a crack, it cannot be closed. As the people of China grow in prosperity, their demands for political freedom will grow as well.”

Similar optimism pours forth from the American press. The Wall Street Journal has commented: “Sooner or later China’s economic progress will create the internal conditions for a more democratic regime that will be more stable, and less of a potential global rival.”

The Washington view has become so widely accepted that almost no one has noticed that there is a second bet on the table—that of the Chinese leadership. It is wagering on a disturbingly different outcome: that a future China can be both rich and authoritarian.

If Washington is right, the future is unclouded, and a fast-rising China can readily be accommodated within the existing Western-defined world order. But what if China’s leaders turn out to understand the Chinese character better than anyone in Washington? What if in 2025 or 2030 the United States finds itself facing off against a China so rich that it has surpassed all other nations in military technology yet remains resolutely opposed to Western values? The implications are hard to exaggerate.

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In the great debate over China’s future, Chinese leaders’ jobs, if not their heads, are on the line. It is reasonable to conclude that they have considered their options carefully. Moreover, they enjoy the advantage of local knowledge. They have studied their nation’s history and know its mind.

Those on the other side are pathetically uninformed. To start, they don’t understand that the Chinese economic system is not capitalism, nor is it converging toward capitalism. China is operating an adaptation of the East Asian economic system. Launched by the Japanese in Manchuria in the 1930s, perfected in Japan proper in the 1950s and 1960s, this system is now widely copied throughout East Asia.

As itemized by Richard Bernstein and Ross Munro in their 1997 book, The Coming Conflict with China, key features of the Chinese version of the East Asian economic model include a labyrinthine system of trade barriers; an artificially undervalued currency; an industrial policy focused on developing pillar industries and using export subsidies to give them competitive advantage; and pressure on foreign companies to transfer their production technologies.

In some ways, the East Asian model resembles capitalism—it makes extensive use of markets, for instance—but its fundamental logic is quite different. Whereas authoritarian political controls constitute a hindrance to growth in the West, they are really essential in the East.

Part of the West’s comprehension problem is ideological: American opinion leaders hold as a matter of high ideology that Western logic is universal and thus destined to sweep the globe. It has not helped that East Asian leaders have gone to extraordinary lengths to keep their Western opposite numbers complacently misinformed.

From a Western point of view, the most glaring problem with the East Asian economic system is its mercantilist approach to trade, but the U.S. continues to unilaterally open its markets ever wider to “one-way free trade.” American policymakers have allowed themselves to be persuaded that East Asian protectionism is merely a temporary adjustment problem and that an enlightened West should simply be patient while the East Asians sort things out.

In reality the East Asians have not the slightest intention of abandoning mercantilism. The point is most obvious in the case of Japan, which as the first East Asian nation to come under sustained market opening pressure from the United States was also the first to invent highly disingenuous methods to forestall American trade negotiators. Even today Japan continues, in targeted industries at least, to pursue a comprehensively protectionist trade policy. Take cars. Despite the fact that, via an investment in Nissan, Renault of France now ostensibly controls Japan’s second largest car-distribution network, there are still virtually no Renault cars on Japanese roads (and, it goes without saying, no American ones).

Japan’s essential mercantilism is strongly reflected in its current account surpluses. Though largely ignored by the American press since Japan’s financial bubble burst in 1990, these have continued to soar with the result that the 2007 figure, at an estimated $201 billion, was nearly four times that of 1989, the peak year of American angst about “juggernaut Japan.”

The experiences of South Korea and Taiwan also offer strong hints of China’s future trajectory. Both adopted the East Asian system in the 1960s, when they ranked roughly as low as China does today in per capita income. They proceeded to enjoy some of the fastest sustained growth in history. As scholar Robert Wade documented, in both cases per capita income measured in current U.S. dollars increased more than 20 times between 1962 and 1986. If the Chinese economy were to match South Korea’s 2008 income level, it would be by far the world’s largest economy, with roughly twice America’s total output.

Asked to identify the secret of Chinese economic growth, Western economists reflexively point to China’s high savings rate. But why do the Chinese save? More important, why do they save more now than they did in the past?

American observers, by virtue of their faith in Western ideology, assume that a nation’s savings rate is merely the aggregate of millions of freely made, uncoordinated decisions by individual savers. This assumption totally obscures the epochal fact that Chinese leaders, in common with their counterparts elsewhere in the region, have established an ingenious, almost invisible, administrative ability to force society to save.

Dozens of government policies have been conceived to suppress consumption, thereby powerfully boosting the savings rate. This approach is hardly new. According to J.K. Galbraith, by curtailing consumption during WW II, Franklin D. Roosevelt’s administration raised the American savings rate from 5 percent to 25 percent in three years. The resulting capital flows underwrote massively expanding production of everything from tanks to fighter planes.

The point was well understood by Japan scholars in the early post World War II period. As far back as the mid-1950s, Harvard-based Edwin Reischauer predicted that suppressed consumption would form the centerpiece of a massive East Asian effort to catch up with the West. History may yet come to recognize this as the most important new insight in economics since David Ricardo came up with the theory of comparative advantage, but it was all but forgotten in subsequent years, perhaps because Japan scholars sensed that frank discussion would make trouble for Japan’s increasingly aggressive economic expansion program in Washington.

Depending on the methods used to suppress consumption, the increased saving sometimes arises in the household sector, sometimes in the business sector. In the latter case this occurs when artificially induced shortages of luxury goods generate huge profits for oligopolistic local suppliers. Provided such profits are reinvested, they count as part of the national savings rate. This explains the paradox that while the macroeconomic data indicates East Asians underconsume, Western media runs stories about East Asians paying exorbitant prices for Louis Vuitton handbags or Rolex watches. While it is easy in East Asia to spend (because prices of luxuries are high), it is difficult to consume (because big spenders get little for their money). The larger economic point is that suppressed consumption creates savings. Exactly where is secondary.

Think of a drain blocked by leaves. No one leaf can stop the flow of water, but 50 leaves are a different matter. The Chinese policy depends on a panoply of constrictions on consumption:

• Trade barriers. If China does not import things, it can’t consume them.
• Credit controls. Consumer credit hardly exists in China and even home loans are rare. Thus those who aspire to own household appliances or cars, let alone homes, must first save prodigiously for years or even decades so they can pay in cash.
• Anti-consumer land policies. China’s zoning policies restrict home size and retail space. Home prices and rents are extraordinarily high relative to incomes, so demand for everything from heating fuel to Swedish furniture is curtailed.
• Corporate price gouging. Price-fixing cartels dominate, so living costs are higher than in other nations at a similar level of development. High prices reduce consumption directly, and the cartels’ profits add to the national savings rate.
• Travel restrictions. The Chinese travel industry is tightly regulated to make it difficult and expensive to take vacations abroad.

A high savings rate is not a sufficient condition for nations to grow. It is important that they invest their savings surpluses not only productively but in ways that avoid destabilizing capacity gluts. In China, as elsewhere in East Asia, industrial cartels help smooth the path by overseeing corporate investment plans, shutting down obsolete capacity, and fixing prices to ensure that member firms earn adequate returns on capital.

All of this requires regulatory oversight and thus a central role by government in the economic growth process.

* * *

By definition, the suppressed consumption policy means that the Chinese people’s living standards constantly lag their productivity. How long will they put up with this? Most Western observers think not very long. Supposedly as living standards improve, Chinese citizens will become increasingly assertive in insisting on consumer-friendly economic policies.

This reckons without the fact that because the Chinese system is so authoritarian, no trend of any significance can develop without at least the tacit approval of those at the top. For a political challenge to achieve critical mass, individuals need some way of setting up associations and communicating with sympathizers. But independent Chinese associations, newspapers, and websites are a contradiction in terms.

China’s leaders are unlikely to co-operate in their own downfall, and given that the Chinese Communist Party controls the People’s Liberation Army, this would appear to settle the matter. It did at Tiananmen Square. And in any case, digital-era authoritarianism rarely has to resort to massive shows of force. Modern surveillance and communication facilitate a preferred strategy of “soft authoritarianism.” Individuals who pose a threat can be identified early and taken out of circulation or rendered ineffectual through denunciation and sabotage. Yet the sort of societal metamorphosis apologists posit can only be driven by freely associating individuals.

In East Asia today, as always in the past, Confucianism plays a decisive role in legitimizing undemocratic, unaccountable forms of government. In the West, we think of groups as amorphous hordes. But in the East, a group is a disciplined, hierarchical entity. Not only are its leaders well defined, but their right to lead is reinforced by institutional structures. Robust methods are available to pressure anyone who wavers. If one individual steps out of line, his group can expect to be punished.

In pre-modern China, an entire family was punished for the offenses of a single member. One of the more Orwellian forms of group punishment in modern China has been identified by Steve Mosher. In his book A Mother’s Ordeal, he writes of how the Chinese establishment whips up societal wrath against couples who flout China’s one-child policy. The government threatens pay cuts for all workers in an enterprise if any of them has a second child. The effect is to co-opt hundreds of workers in pressuring a woman to have an abortion.

* * *

If the rise of Chinese power were the only thing to worry about, America’s geopolitical quandary would be serious. But another, almost equally serious concern is America’s precipitous decline.

Few witnesses are better placed to testify than Andrew Grove, chairman of Intel. Speaking to Newsweek in 2006, he said: “America … [is going] down the tubes and the worst part is nobody knows it. They’re all in denial, patting themselves on the back, as the Titanic heads for the iceberg full speed ahead.”

Then there is the world’s most successful investor, Warren Buffett: “The U.S. trade deficit is a bigger threat to the domestic economy than either the federal budget deficit or consumer debt and could lead to political turmoil.”

Nowhere is American weakness more apparent than in advanced manufacturing. Leadership in this category has long been a sine qua non for a superpower. Indeed, America’s mid-20th-century dominance was based on little else. But those industries have been so eviscerated that a 2005 Department of Defense report pronounced America’s security at dire risk. “There is no longer a diverse base of U. S. integrated circuit fabricators capable of meeting trusted and classified chip needs,” the report said. “From a U.S. national security view, the potential effects of this restructuring are so perverse and far reaching and have such opportunities for mischief that, had the United States not significantly contributed to this migration, it would have been considered a major triumph of an adversary nation’s strategy to undermine U.S. military capabilities.”

As corporate America loses share in world markets, other nations have been quick to fill the void, not least China. Here is a sampling of how fast China has been turning the tables on the U.S.:

1. China’s foreign currency reserves are now the largest in world economic history, having multiplied more than sixfold since the end of 2001.
2. In partnership with other major East Asian central banks, the People’s Bank of China effectively controls American interest rates and the value of the dollar.
3. Chinese interests have established control of the formerly American-owned Panama Canal. The key ports at either end have been bought by a Hong Kong tycoon regarded as a Beijing surrogate. He also controls ports on Mexico’s Pacific coast that are playing an increasing role in shipping Chinese goods to the American market.
4. Chinese and other East Asian interests now largely control the network of satellites and undersea cables that makes up the international telecommunications system. The system had been under American control until our high-technology stock crash, when dozens of telecommunications companies on the verge of bankruptcy were bought by East Asian interests.

Many commentators insist that the U.S. is turning the corner, but the international trade figures tell a different story.

Up to a generation ago, the U.S. ranked as the world’s strongest trading nation on almost every measure. Now its huge trade surpluses are a distant memory and it ranks first in a dolefully different category—as the world’s largest deficit nation.

As of 2007, moreover, the U.S. was passed by China in the total value of its exports. As recently as 1996, the United States out-exported China by four to one. Japan now buys more than 60 percent as much from China as from the United States. By contrast, as recently as 1991, Japan bought nine times as much from the U.S. as from China.

Perhaps the unkindest cut of all is that the U.S. no longer even counts as China’s largest source of imports: Japan holds that position, and its exports to China are twice America’s.

* * *

Americans continue fondly to believe that America is changing China, but the opposite is true. Certainly Westerners who do business there are modifying their behavior—often quite troublingly—under Beijing’s influence. Picture a phalanx of chocolate soldiers marching into a blowtorch.

Hitherto the most common manifestation of this phenomenon of reverse convergence is in the fact that Western organizations increasingly do business “the Chinese way.” Not to put too fine a point on it, they allow themselves to be compromised. This generally means putting themselves on the wrong side not only of Chinese law but Western law. They are induced, for instance, to embrace Chinese business’s notorious culture of bribery and corruption. Those who try to give that culture a suitably wide berth can kiss goodbye to their hopes of ever succeeding in the fabled Chinese market. Writing from Shanghai in 2005, Peter S. Goodman of the Washington Post commented, “American business leaders often describe their China operations idealistically, suggesting that their presence here will compel Chinese competitors to adopt more ethical business practices. But in one key regard, the dynamic operates in reverse, with U.S. companies adopting Chinese-style tactics to secure sales, as they compete in a market in which Communist Party officials routinely control businesses, and purchasing agents consider kickbacks part of their salary.”

In the words of Carolyn Bartholomew, former chairman of the United States-China Economic and Security Review Commission, many American companies have made “Faustian bargains” with Beijing. She cites Yahoo!, Google, and Microsoft, which have agreed to abide by China’s censorship rules in serving Chinese Internet users. Yahoo! voluntarily handed over evidence that led to one Chinese Internet user being sentenced to ten years in prison. Bartholomew commented, “Far from capitalism changing the Chinese government, it is the Chinese government changing capitalists. Rather than the birth of freedom with telecommunications and the Internet serving as the handmaiden of democracy, we have the Internet entrepreneurs selling rope to the hangmen.”

In a world that has been drastically shrunk by fast travel and cheap telecommunications (not to mention intercontinental missiles), it is hard to see how Confucianism and Western individualism can continue to coexist as equals. By proclaiming American values not only more desirable but inherently stronger, Washington has virtually guaranteed that Beijing’s rejoinder will be a sotto voce “We’ll see.”

The fast developing Sino-American clash is the economic and political equivalent of a collision between matter and antimatter. Chinese leaders are generally much more discreet than they once were in rejecting American efforts to project Western values into China, but they still regard America’s democracy talk as a dire threat to their personal positions, if not to the Chinese way of life. They may not be looking for war, at least not against the world’s major nuclear powers, but they are probably mindful of Sun Tzu’s maxim: “to subdue the enemy without fighting is the acme of skill.”

The betting is that China will penetrate American society by stealth. Building on the extensive if unobtrusive groundwork laid by earlier East Asian industrializers, China can be expected in the fullness of time to become a major factor in shaping outcomes in Washington. That won’t be as difficult as Americans might assume: the effect of globalism has been to create a political vacuum in Washington where an alert eye to the U.S. national interest was once present.

Of particular concern is how well Western intellectual organizations will withstand the pressures. Take the Western media. The idea that they might come off second best in any face-off with Confucian-style censorship may seem preposterous, but evidence from elsewhere in the East Asian region suggests that for decades the Western press has increasingly embraced Confucian-style “self-control.” The Western press has long seemed to avoid sensitive issues, such as Japan’s war reparations policy. Even trade policy often seems too hot for the Western press to handle, particularly where advertising revenue might be at risk. When was the last time a major American newspaper took a searching look at the car markets of Japan or South Korea? While Chinese advertisers are as yet only a tiny factor in Western markets, that may change rapidly.

Top American Internet companies have already reneged on Western values in pursuit of lucrative business in their Chinese subsidiaries. How long before they prove similarly malleable in their domestic operations? Writing for the New York Times on a conference in Shanghai in 2005, Tina Rosenberg recounted how top American business leaders fawned on Chinese Communist Party officials. She added: “Let’s not pretend that foreign investment will make China a democracy. That argument was born out of desperation and self-interest. Because China is too lucrative a market to resist, American and European businessmen have ended up endorsing the party line through their silence—or worse. They are not molding China; China is molding them.”

Any American who understands the dynamics by which the Chinese empire has been held together over the last 3,000 years will not be sanguine about the outcome. It is time Uncle Sam looked over his shoulder: his coattails are caught in the jaws of a dragon.
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Eamonn Fingleton writes from Tokyo. This essay is adapted from In the Jaws of the Dragon, released this month by St. Martins Press. Used with permission.