China is militarising one of the world’s most important shipping channels, the South China Sea. What will be the impact on trade? Nigel Wilson reports.


When Song Zuying performed in the Spratly Islands in May, the Chinese “military folk” singer was the main attraction in a 50-strong troupe of artists.

Photographs posted by the Chinese state news agency Xinhua showed Chinese construction workers, colourful glow sticks in hand, dancing before Song, who stood tiny on the distant stage. In the background, a huge warship was docked.

Other pictures and videos offered glimpses of military personnel enjoying the show, amid buildings, runways and an air traffic control tower on the island that China calls the Fiery Cross Reef. It was a clear attempt to portray who is in charge in this long-contested part of the South China Sea.

The reef, which China has transformed into an artificial island via a massive dredging operation, is part of the disputed Spratly archipelago. Several Southeast Asian countries, including Malaysia, Vietnam and the Philippines also claim sovereignty over the territory and have done so for decades.

The Spratly dispute is just one of many in the South China Sea that have resurfaced as China has sought to establish its supremacy there in recent years, building islands and infrastructure, and maintaining its claim that almost all of the sea is within Chinese territorial waters.

“There are two sets of disputes: The disputes about the islands, which just involve the countries around the sea – China, the Philippines, Malaysia, Vietnam, Brunei and Indonesia to a lesser degree. Then there are conflicts about the spaces in between the islands, which are really between China and the US and the laws of the sea and who can decide who sails where,” says Bill Hayton, associate fellow at Chatham House.

During the presidency of Barack Obama, the US has worked to boost diplomatic and trade links with regional economies to such an extent that its presence is largely welcomed by most of the countries as a counterbalance to Chinese power. The US has conducted so-called freedom of navigation operations in the sea, whereby the American military sailed within 12 nautical miles of disputed territories. In April, the US announced that it would conduct joint military drills with the Philippines in the South China Sea.

“It seems that China wants to close off the sea, certainly for military access, to the US. Obviously the US is going to resist that. The real danger lies in the overlap between the territorial dispute and the more global dispute,” says Hayton.

“In a worst-case scenario, some kind of confrontation could get out of hand. People could miscalculate and we could end up with a shooting incident. The danger might come from some kind of attempt by the Chinese to use, for example, civilian fishing boats to impede an American ship and try and muddy the waters between what’s civilian and what’s military. Or there could be some kind of confrontation which is outside the control of governments really, maybe between a couple of fishing boats or something which then escalates,” he adds.

In July, thing took a dramatic turn when the UN’s court of arbitration in The Hague ruled that China’s claims on certain South China Sea territories were incompatible with the laws of the sea. The court ruled more strongly in favour of the claimant – the Philippines – than expected, leading to speculation that additional countries such as Vietnam would bring further cases, and about the potential disruption the ruling would have on the world’s busiest trade route.


Channel hopping

The South China Sea is a vital and busy trade and shipping route, linking the Pacific Ocean and the Indian Ocean via a number of straits around Singapore, Malaysia and Indonesia in the south and Taiwan in the north. An estimated US$5tn-worth of global trade passes through the South China Sea annually, including up to half of all global oil tanker shipments, according to the Council on Foreign Relations. It also sees three times more traffic than the Suez Canal and more than five times that of the Panama Canal.
The US has stated that its priority is to ensure that this freedom of movement and trade will be respected not impeded by the unilateral actions of states in the region. So far, the recent military build-up in the South China Sea has not affected the trade routes. However, a potential confrontation and escalation would deliver a blow to a number of the region’s economies.

“If ever there were any trouble it would be critical for many countries. Not just China and the US, but Japan, Taiwan, South Korea. A lot of countries’ trade goes through there,” says Hayton.

“It might be possible to route some of that trade via other routes but then you’re either going through Indonesian internal waters, or there’s a rather tricky bit of navigation between Indonesia and Australia, or you’re going around Australia which is a massive detour so it would add to costs in a considerable way. It would impact a lot on costs, logistics and insurance.”

While the growing Chinese and American military presence has heightened the risk of a confrontation with potential for escalation, the past 12 months have been relatively stable compared to 2011, when Chinese ships repeatedly clashed with the Vietnamese coastguard. The US and Chinese navies have established a working dialogue, while China appears to have slowed some of its oil exploration activities in disputed areas.

“I would caution against saying that the dispute as a whole is becoming more militarised. These are all relatively minor moves in the grand scale of things.
We haven’t seen in a very long time anything of the sort of move where China overturned the ownership or the de-facto possession of a territory in the South China Sea,” says Duncan Innes-Ker, regional director for Asia at the Economist Intelligence Unit.

“There seems to be a bit of a status quo developing in the region where the potential to shift ownership of territory is possible without provoking a severe escalation. I don’t see a great willingness on China’s part to take further territory at the moment. They will maintain their claim of course, but they seem unwilling to engage in the direct conflict that would be necessary to take further territory,” he adds.


The art of the deals
The political disputes between the US and China come as the two powers seek to entrench their economic relations in the region through new trade deals. The US-led Trans Pacific Partnership (TPP) was signed off in February but the deal is unlikely to be ratified by the US this year, as we approach the presidential election.

Among the TPP signatories are seven states which are also currently negotiating the Regional Comprehensive Economic Partnership (RCEP,) a free trade proposal that includes China but not the United States. Negotiations over the proposed 16-country free trade zone are due to be complete by the end of 2016, but this deadline is also highly unlikely to be met.

TPP and RCEP have often been portrayed by politicians and media on either side as rivals to one another and part of a greater contest between China and the United States for political, military and economic supremacy in the region.

“There are people who have made the argument that one of the reasons Vietnam has been so quick to embrace the TPP in particular is because of concerns about the South China Sea and Vietnam’s worries over its vulnerability and its desire to be closer to allies in the TPP, both economically and militarily. So the TPP gives the Vietnamese another platform to engage with potential allies in the region,” says Deborah Elms, executive director at the Asia Trade Centre.

The notion that the TTP was in competition with the RCEP was even promoted by Barack Obama in a Washington Post op-ed in early May, where he wrote that China was working to cut up markets at American expense and urged for a quick ratification of the TPP.

In an American election year, a certain amount of hostile rhetoric towards Chinese trade practices is to be expected, but some analysts believe that establishing this dynamic could be unhelpful in the long-term.

“To frame this [RCEP] as a China-led approach is a very poor strategy, for multiple reasons. I don’t think factually it’s correct. I don’t think the RCEP is China-led,” says Elms.

“I think it sets up long-term problems for the US, for China, for the TPP and the global economy to set this up as a US vs China discussion. In the end, you need to have co-ordination across these trade agreements in order for them to be more effective. At some point, I would argue, you really need to have China in the TPP or in a similar type of agreement. And that cannot be done if you have painted them into an adversary, in an attempt to get the TPP ratified by the US Congress.”

However, with the TPP agreed upon and on the road to ratification in the US, the RCEP negotiations will continue through 2016. Leaders hope to conclude a deal this year but such an outcome is far from certain.

“The major problem with the RCEP is that nobody is leading. Officially, it’s being led by Asean, which means that 10 countries are trying to lead this very challenging set of negotiations. Anything led by 10 is by definition hard to do and I think that is the real obstacle that RCEP faces, in that you’re trying to lead by committee and that’s not easy,” Elms says.

As far back as the 16th century, British seafarer Sir Walter Raleigh said: “For whosoever commands the sea commands the trade; whosoever commands the trade of the world, commands the riches of the world, and consequently the world itself.” The nexus of global trade’s most important region lies in the South China Sea: whichever of the superpowers vying for supremacy comes out on top, may dictate the future of trade itself.


South China Sea dispute: the expert view

In July, a Permanent Court of Arbitration at the United Nations in The Hague ruled that China’s claims on territories in the South China Sea were not compatible with the laws of the sea.

The court ruled in favour of the Philippines, one of numerous states to lay claim to nautical territories that are thought to be resource-rich, but which are also part of a vital trade route.

GTR spoke to Rajiv Biswas, chief economist for Asia Pacific at IHS, to discuss the impact of the ruling on regional trade.

GTR: To what extent have ongoing disputes in the South China Sea already damaged trust and relations between the various states involved?

Biswas: The protracted disputes about the sovereignty of various areas of the South China Sea have become one of the key geopolitical risks in Asia Pacific. Tensions between China and Vietnam escalated into widespread anti-Chinese riots in Vietnam in May 2014 after China sent an offshore oil rig into an area of disputed sovereignty, forcing China to evacuate its citizens from Vietnam.

Relations between China and the Philippines were also severely damaged in recent years over the South China Sea dispute, although incoming President Duterte has proposed negotiations with China in order to settle the dispute. China’s territorial claim as set out by the nine-dash line also overlaps with Indonesia’s territorial waters around the Natuna islands. There have been several incidents this year when Indonesian naval vessels have opened fire on Chinese fishing vessels around the Natuna islands, as well as seizing ships illegally fishing in Indonesian waters.

GTR: How does this tension affect regional trade?

Biswas: If tensions remain high between China and various Southeast Asian countries over the disputed sovereign claims in the South China Sea, this could have a negative impact on bilateral trade and investment flows between these nations and China. Due to the importance of the South China Sea as a key international shipping route, there is also growing concern about the risk that escalating military presence and potential naval confrontation in the South China Sea could impact upon the freedom of navigation for international shipping. The US Navy is currently undertaking operations in the South China Sea to protect the international freedom of navigation, with the USS Ronald Reagan Carrier Strike Group currently in the South China Sea.

GTR: Do you view the TPP and RCEP as products of these territorial disputes, with the US and China pursuing respective agreements as a means of stamping authority on the region?

Biswas: The Obama administration has pushed strongly for the TPP as part of its broader pivot to Asia to strengthen its economic and political engagement with the APAC region. This mainly reflects a strategic recognition of the growing economic and political importance of the Asia Pacific region for the US, rather than a narrow focus on the South China Sea dispute. However, as one of the key pillars of the US pivot to Asia, the TPP is part of the broader US strategy to maintain its political and economic importance in APAC in the face of China’s economic ascendancy.

GTR: What bearing will the UN’s verdict have on regional trade, if any?

Biswas: The implications of Permanent Court of Arbitration tribunal ruling regarding the South China Sea territorial dispute represent a significant blow to China’s territorial claims in the South China Sea. There are some fears that the Permanent Court of Arbitration ruling, which is unfavourable to China, could provoke a further escalation in the Chinese response. Therefore, much will depend on whether China decides to ignore the Permanent Court of Arbitration ruling and unilaterally continue its build-up in disputed areas of the South China Sea, or if some kind of regional dispute resolution settlement can be negotiated. At present tensions remain high and if the military confrontation escalates, this could impact upon regional trade and investment between China and some Asean countries, as well as creating risks to freedom of navigation for international shipping.

GTR: This verdict is unlikely to be the last we hear of this story: how do you see this playing out? Do you think armed conflict is likely?

Biswas: The South China Sea sovereignty dispute has escalated in the last three years into one of the world’s most significant geopolitical risks. While China is unlikely to want to provoke a South China Sea conflict, regional leaders from APAC countries, including Australian prime minister Malcolm Turnbull, have increasingly spoken out about their concerns that an accidental military clash in the South China Sea could escalate.

There has already been an escalation of military tensions in the South China Sea, with both Vietnam and the Philippines trying to modernise their armed forces to have a greater deterrent capability to protect their sovereign interests. While the risk of armed conflict remains low, this is a downside risk scenario that is of increasing concern to APAC governments, due to the possibility of an accidental clash between naval ships or fighter jets in a heavily militarised area.