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Asia Power TrendsM A R C H 2 0 1 9

Washington, DC | Hong Kong

www.theasiagroup.com

The Asia Group (TAG) is a strategic advisory firm co-founded in 2013 by Kurt Campbell and Nirav Patel that helps the world’s leading companies and investors advance business and market strategies throughout the Indo-Pacific region. Built on decades of senior-level experience in diplomacy, finance, law, industry, and academia, TAG has cultivated unique networks and expertise at the highest levels of government and business across Asia.

TAG’s global engagements cut across a broad range of industries that include technology, media, financial services, manufacturing and apparel, health and pharmaceuticals, tourism and hospitality, energy and mining, aerospace, and defense.

TAG also operates an analytics and risk advisory division that produces cutting-edge trade, commercial, and geopolitical analysis of trends impacting the Indo-Pacific and a daily newsletter on the most consequential developments in the region, TAG Capital, a boutique investment bank that specializes in cross-border transactions, and the TAG Foundation, which provides grants as well as pro-bono advisory work to support high-impact nonprofits.

The State of Asia

The Asia Group operates on a core premise: the Asia-Pacific is today the most economically and politically important region in the world and will be for the rest of the 21st century. Home to 60 percent of the world’s population and accounting for more than one-third of the world’s gross domestic product, Asia is the manufacturing and commercial engine of the world and the most consequential arena for a new era of global security competition. But for all of the opportunity that Asia presents today, the region is in flux. Geopolitical, nationalist, economic, and regulatory developments stand to dramatically change the Indo-Pacific and test individual countries within the region. In the following pages, we identify ten “Power Trends” that we believe will have an outsized impact on Asia in the near future. Asia is being reshaped by a United States that has stepped back from its traditional stabilizing role in the region, a shifting, possibly fragmenting trading environment, and rising volatility and geostrategic risk. The most important bilateral relationship in the world – that between the United States and China – is more complex and more competitive. Regional states are dealing with economic headwinds and reform imperatives, some of which have the potential to alter global supply chains. The technological landscape is shifting, raising new questions about the role of governments and the rise of artificial intelligence. The United States and North Korea remain in an unstable equilibrium. And climate change may be the greatest long-term challenge for the continent. This is by no means an exhaustive list of trends that will shape Asia, but we believe these are some of the most important factors at the intersection of business and public policy. Executives and policymakers operating in Asia must remain intensely focused on the changes underway in the region – which bring with them both risk and opportunity. We hope our report provokes new thinking about these forces and how they will impact Asia.

Best,

Dr. Kurt M. Campbell Dr. Siddharth MohandasChairman and CEO Director of Research

T H E A S I A G R O U P2

Asia Power Trends

1 THE TRUMP FACTORAsia Hedges Against an Uncertain America

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XI AND TRUMP

RISING GEOSTRATEGIC RISK

TRUMP’S PERILOUS DIPLOMATIC GAMBIT WITH NORTH KOREA

SUPPLY CHAIN SHAKE-UP

The World’s Most Important Relationship Gets More Unpredictable

Asia’s Powers Flex Their Muscles

The Dangerous Gap Between “Success” and Denuclearization

Companies and Countries Adjust to New Realities

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10

RISING TRADE TENSION

WASHINGTON TAKES ON BEIJING

KEY ASIAN ECONOMIES SHOW SIGNS OF STRAIN

TECHLASH

CLIMATE CHANGE CONUNDRUM

A New Economic Landscape

A Decades-Long Bipartisan Consensus Shifts

Reform Agendas Face Challenges

Privacy, Artificial Intelligence, and Security Concerns Define a New Regulatory Landscape

Fossil Fuels and the Climate Change Economy

A S I A P O W E R T R E N D S 3

he election of U.S. President Donald Trump has forced Asia to grapple with a new reality, as Washington appears poised to turn its back on the post-World War II international system. In the first two years of Trump’s presidency, Asian leaders have had to adjust to his inflammatory rhetoric and tweets. Regional confidence in the president remains low, as countries continue to adjust their economic and

security strategies in response to Trump’s “America First” doctrine. After the departure of U.S. Defense Secretary Jim Mattis, few guardrails remain to prevent Trump from advancing policies that could undermine traditional alliances and norms. What to Watch: Japan’s and South Korea’s relations with China, challenges in U.S. bilateral defense and trade agreements with allies, greater intra-Asian cooperation.

1 Asia Hedges Against an Uncertain America

Trump has governed by tweet, firing his first secretary of state, Rex Tillerson, and frequently making pivotal policy announcements on the platform. Allies and competitors alike have had to adjust to the fact that Trump will continue to use social media as a bully pulpit in unprecedented ways.

After President Trump took office, many in Asia reacted negatively to the new direction and style of U.S. policymaking. In some countries, confidence in the U.S. presidency dropped by more than 50 percent. While individual leaders, such as Japanese Prime Minister Shinzo Abe and Chinese President Xi Jinping, have worked to establish a personal rapport with Trump, often engaging in flattery and praise in an attempt to appease him, their citizens remain uneasy about the president’s actions.

Source: Pew Research Center

TThe Trump Factor


Asia Reacts

Tweeter-in-Chief

CONFIDENCE IN THE U.S. PRESIDENT

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Vietnam

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64

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7158

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24

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40

Around the region, Asian leaders have, in their own ways, sought to adopt hedging strategies built around the following core components: • Keeping relations stable with the United

States• Investing in their own defense capabilities• Reaching out to like-minded countries• Making their own “best deal” with China


Japan

India

South Korea

Australia

ASEAN

Hedging Behavior

Japanese Prime Minister Shinzo Abe has worked to maintain a strong personal relationship with Trump. But as tides shift in Asia, Abe is increasingly hedging through outreach to Chinese President Xi Jinping – a trend likely to continue.

Even as U.S.-India defense ties have grown, the Indian government has sought to keep its options open, including through the purchase of Russian S-400 missile systems – a move that irritated Washington.

The Australian government is committed to working with the United States but has turned to Japan and India as well in an attempt to revive the “quad” concept to counteract China’s rising influence.

South Korean President Moon Jae-in’s dramatic diplomatic efforts have the potential to radically change the status quo on the Korean Peninsula. As Trump calls on Seoul to take greater ownership of its own security, Moon has met with both Xi and North Korean leader Kim Jong-un.

Trump’s withdrawal of the United States from the Trans-Pacific Partnership disappointed many member states of the Association of Southeast Asian Nations, prompting them to seek greater economic engagement with other partners, including China, and with each other.

Source: U.S. Census Bureau Source: U.S. Commerce Department

A fter decades of movement toward freer trade and more-open markets, the region is adjusting to a more protectionist landscape. As a candidate, President Trump vowed to reverse U.S. trade policies, blaming trade deficits for souring U.S. economic growth and harming domestic manufacturers. In 2018, Trump made good on longstanding threats to impose tariffs against economic competitors and

partners alike, but so far, he has failed to deliver on a new, integrated trade vision for the Indo-Pacific region following U.S. withdrawal from the Trans-Pacific Partnership (TPP). Instead, the Trump administration has sought to conduct trade relations on a bilateral basis and has placed significant pressure on India, Japan, and especially China to find ways to reduce their bilateral trade surpluses with the United States. To date, Washington has not succeeded in reducing its global trade deficit, possibly portending further punitive measures in 2019. What to Watch: new bilateral trade agreements, Asian trade deals that exclude the United States, additional U.S. trade measures targeted at certain sectors (e.g., technology).

Trump’s overall goal of reducing the U.S. trade deficit still remains unmet. His tariffs have failed to substantially reduce monthly deficits, instead leading to an increase in the deficit as countries impose retaliatory measures. The president has made reducing the trade deficit a cornerstone of his economic policy, so if current trends continue, the Trump administration may look to take further aggressive actions.

2 A New Economic LandscapeRising Trade Tension

U.S. BILATERAL TRADE DEFICITS

Exports Imports

- USD BILLIONS IN 2017 - Australia

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U.S. GLOBAL TRADE DEFICIT - MONTHLY, IN USD BILLIONS -


Focus on Bilateral Trade Imbalances

Trump’s Asia

Trade Deal

Check List

The KORUS revision:• Allows the U.S. to

continue a 25-percent tariff on Korean trucks until 2041

• Doubles the cap on U.S. auto imports to 50,000 from 25,000

• Excludes South Korea from steel tariffs

In the trade war with Beijing, the Trump administration has sought: • The end of “Made in

China 2025” industrial subsidies

• To prevent forced technology transfer and increase IP protections

• Increased purchases of U.S. goods

USTR Lighthizer has led a trade dialogue with Tokyo, though Japanese officials remain wary of U.S. demands to:• Open up the Japanese

market to U.S. agricultural products

• Accept a trade framework that reduces auto exports

Section 201: In Jan-uary 2018, President Trump approved new safeguard mea-sures after a U.S. investigation found certain U.S. indus-tries were injured by imports. The mea-sures include tariff rate quotas on solar cells and washing machines, as well as increased tariffs on solar panels.

Section 232: These investigations look to determine the national security implications of certain classes of imports. The Trump ad-ministration has con-cluded investigations into steel and alumi-num imports, imposing tariffs and quotas to protect U.S. industry, and is completing an investigation into auto imports, with the po-tential for additional tariffs.

Section 301: The prin-cipal tool in the trade war with Beijing, these investigations into China’s theft of U.S. intellectual property (IP) and other unfair trade practices have resulted in the follow-ing tariffs:• A 25-percent tariff

on USD 50 billion worth of trade in Chinese goods

• A 10-percent tariff on USD 200 bil-lion worth of trade in Chinese goods

Sanctions: Trump has also used sanc-tions and the threat of sanctions to in-fluence the region. Washington has ef-fectively persuaded multiple countries to draw down oil pur-chases from Iran, successfully raised pressure on North Korea (although for how long remains to be seen), and sought to aggressively pros-ecute violators of sanctions.

South Korea China Japan


A New Willingness to Use Trade Measures...

...to Secure Trade VictoriesTrump campaigned on a pledge to abandon the TPP and has since harshly denounced multilateral trade deals, even as he secured a renegotiation of the North American Free Trade Agreement. Supported by U.S. Trade Representative (USTR) Robert Lighthizer, Trump has instead sought to negotiate bilateral trade agreements across Asia, including with South Korea, China, Japan, the Philippines, and Vietnam. On September 24, 2018, Trump and South Korean President Moon Jae-in signed a deal to revise the U.S.-Korea Free Trade Agreement (KORUS).

Donald Trump’s election in 2016 stunned Chinese officials, forcing Beijing to deal with a U.S. president who promised during his electoral campaign that he would aggressively crack down on China. Despite multiple summit meetings since Trump’s inauguration, Chinese President Xi Jinping and Trump remain deeply at odds on key aspects of the relationship. Both leaders have turned to trusted lieutenants to manage

relations, yet many of these senior officials have walked away from meetings with little progress to show and their own credibility questioned. But as tensions rise, both Trump and Xi will have to play an active role in managing bilateral engagements. The fate of the U.S.-China relationship will depend on whether the two presidents can work together to avert crisis, even as they both advocate for their respective priorities. What to Watch: whether Trump continues to praise Xi, outcomes from new summits, whether hawkish advisors on both sides gain prominence.

3 The World’s Most Important Relationship Gets More Unpredictable

Xi and Trump

Managing the Relationship

Trump’s Relationship with ChinaPresident Trump has a bitter history with Beijing, after his unsuccessful attempts to open a Trump property in China. However, he has personally sought to develop a strong relationship with President Xi, whom he continues to call his friend. Trump reportedly was very impressed with Xi after the Chinese leader feted him with a “state visit plus” during his visit to Beijing in 2017.

Xi’s Relationship with the United StatesWhile Trump has enthusiastically celebrated his relationship with Xi, the Chinese leader has expressed more muted feelings toward the U.S. president publicly. Xi has significant knowledge of the United States, having studied in Iowa in 1985, but he and other Chinese officials have struggled to interpret Trump’s ascendancy in U.S. politics.


The Issues

Beijing has long defined Taiwan as a breakaway province but in recent months has increased assertive rhetoric and diplomatic pressure on Taipei.

Beijing’s Take Washington’s TakeTaiwan After he was elected, Trump took a controversial

congratulatory call with Taiwanese President Tsai Ing-wen, prompting immediate criticism from Chinese officials. His administration has increased the pace of arms sales to Taipei.

Xi has welcomed U.S. diplomacy with North Korea, but Chinese officials have sought to coordinate with Pyongyang.

North Korea

Trump’s diplomacy with North Korea represents one of his most significant foreign policy initiatives to date. Washington welcomes Beijing’s interest but remains wary of Chinese intentions.

Beijing has embraced industrial and cyber policies that advantage Chinese companies, including “Made in China 2025” – a plan that provides subsidies to Chinese technology sectors.

Industrial and Cyber Policies

The Trump administration has harshly criticized China’s industrial subsidies, including “Made in China 2025,” and cyber policies. Even after China’s accession to the World Trade Organization, Washington worries that Beijing retains inappropriate influence over industry.

The AdvisorsXi’s Team Trump’s Team

Vice President Wang Qishan• One of Xi’s most trusted lieutenants and a

crucial advisor on bilateral relations• Maintains strong ties with U.S. corporate

executives

Vice Premier Liu He• Oversees trade talks with the United States• Visited the United States multiple times to meet

with U.S. negotiators

Foreign Minister Wang Yi• Oversees day-to-day relationship management

with Washington • Has become more influential since becoming a

state councilor last year

Secretary of State Mike Pompeo • Has held hawkish views about China since his

days as a member of Congress • Encourages U.S.-China cooperation on North

Korean denuclearization

Treasury Secretary Steven Mnuchin• As a former Wall Street executive, has embraced

largely establishment trade views• Reports of some tension with Trump and more-

hawkish advisors in the administration

Trade Representative Robert Lighthizer• Has overseen the latest trade talks with China

and maintains a hawkish stance• Served as the Deputy USTR during the Reagan

administration

Politburo Member Yang Jiechi• Has long served as one of China’s main

interlocutors with the United States• Although not particularly close with Xi, serves on

the powerful Politburo

Ambassador to the U.S. Cui Tiankai• Longest-serving Chinese ambassador to the

United States since his appointment in 2013• Makes frequent media appearances warning of

the consequences of U.S.-China tension

Trade Advisor Peter Navarro• Longtime critic of China’s economic policies and

one of Trump’s most hawkish advisors• Has criticized Wall Street for encouraging U.S.-

China engagement

Senior Advisor Jared Kushner• Trump’s son-in-law• Originally served as one of the president’s chief

envoys to China, helping orchestrate Trump’s meeting with Xi at Mar-a-Lago in 2017

Through the Belt and Road Initiative, China intends to provide up to USD 1 trillion in infrastructure financing – though the investments often come with strings.

RegionalInvestment

In 2018, the United States unveiled plans to incentivize investment in the Indo-Pacific, including through a new USD 60 billion global investment fund.


S ince the U.S. opening to China in 1972, the prevailing view in Washington policy circles has been that Beijing could be transformed into a responsible global stakeholder through inclusion in international institutions. Today, U.S. officials and legislators on both sides of the aisle are reassessing China’s willingness to step into that role. The rise of Xi Jinping and his policies are leading officials to

acknowledge that China may not be on a path to greater liberalization. While 2018 brought significant attention to U.S.-China trade imbalances, Washington’s problems with Beijing run much deeper. As U.S. Vice President Mike Pence outlined in a speech last October, China’s behavior has led U.S. officials to reconsider the longstanding consensus, with some officials now preferring policies akin to containment. What to Watch: additional restrictions on technology trade and investment, growing U.S. defense expenditures focused on China, increased attention on Chinese influence in the United States.

The Speech

4 A Decades-Long Bipartisan Consensus ShiftsWashington Takes on Beijing

Beijing is employing a whole-of-government approach, using political, economic, and military tools, as well as propaganda, to advance its influence and benefit its interests in the United States. China is also applying this power in more proactive ways than ever before, to exert influence and interfere in the domestic policy and politics of this country.

Vice President Mike PenceOctober 4, 2018

Vice President Pence’s speech on October 4, 2018, at the Washington-based Hudson Institute included a litany of U.S. complaints against China, underscoring a new tenor in bilateral relations under the Trump administration. Pence criticized China’s trade and defense policies and alleged that Beijing had embarked on extensive influence operations and propaganda campaigns within the United States, even including interventions in U.S. elections.

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Japan

South Korea

Prime Minister Shinzo Abe has begun a quest to reform Japan’s pacifist constitution, as the country’s military continues to upgrade its arsenal by:• Acquiring strike capabilities – both air-based (F-35, F-15, F-X)

and ship-based – and purchasing K-46 tankers to extend the range and endurance of aircraft

• Developing satellite systems that enable improved ISR (intelligence, surveillance, and reconnaissance)

• Installing two land-based Aegis Ashore batteries to enhance ballistic missile defense, in light of advances in North Korean and Chinese ballistic missile capabilities

• Repurposing a helicopter carrier to enable the launch of fighter aircraft

South Korea is focused on enhancing its capabilities to take over operational control of its defense from the United States, including by:• Pursuing counter-fire capabilities to suppress North Korean

long-range artillery in the Kaesong Heights• Developing indigenous medium- and long-range surface-to-air

missile systems and ballistic missile defense capabilities as part of its Korean Air and Missile Defense program

• Purchasing three additional KDX III Aegis destroyers to complement the three it already has

IndiaPrime Minister Narendra Modi’s government has recently increased defense expenditures seven percent, enabling India’s military to achieve a number of its priorities, including:• Constructing an indigenous aircraft carrier (INS Vikrant)

to complement its single operational aircraft carrier (INS Vikramaditya)

• Continuing nuclear deterrence patrols, after the INS Arihant nuclear-powered ballistic missile submarine conducted its first such patrol in November

• Developing intercontinental ballistic missile technology, including the Agni V (5,500 km range) & VI (8,000 – 10,000 km range)

Ongoing trade frictions with the United States have put significant pressure on China’s economy and continue to test Beijing’s political will to continue its deleveraging program. China now faces several challenges simultaneously, threatening to sour the growth outlook for 2019 and constraining top officials’ choices: • Slowed Exports – While China’s exports initially

held up in the face of U.S. tariffs, their growth slowed markedly amid struggles in the auto market and as the boost from front-loaded import orders wore off.

• Massive Debt – Past stimulus policies enabled a debt buildup that now poses serious risks to China’s financial system. While regulators have undertaken a wide-ranging campaign to scale back lending and reduce systemic risk, the dampening effect is compounding the economic impact of the trade war.

• Private-Sector Struggles – The government’s clampdown on shadow banking – a core component of deleveraging – reduces credit to the private sector, complicating Beijing’s efforts to prime domestic demand.

China

6 Reform Agendas Face Challenges

Key Asian Economies Show Signs of Strain

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SHANGHAI COMPOSITE AND CHINESE MONEY SUPPLY GROWTH

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Shanghai Composite Index

Chinese M2 Growth (YoY, percent)

Source: Wall Street Journal, People’s Bank of China

Bipartisan AgreementAlthough Washington has become more polarized since Donald Trump was elected, Republicans and Democrats alike have embraced Trump’s new approach to China. Many Chinese officials reportedly believe that the Democrats’ strong performance in congressional midterm races may prevent Trump from embracing more-hawkish policies; however, contrary to Beijing’s hope, Democrats remain very wary of China, especially as some within progressive circles claim that its industrial policies have hollowed out American industry. The bipartisan passage of a bill expanding the scope of the Committee on Foreign Investment in the United States (CFIUS) underscores how liberal politicians have also embraced this “new normal.” Indeed, some Democrats have even criticized the president for not being tough enough on Beijing.

Trade and Investment

“China will bark back. But they need us more than we need them — President Trump is right about that — and we should be strong.”

The Trump administration and Congress have adopted new laws and regulations that restrict trade and investment with China.• The Trump administration introduced tariffs on USD 250 billion of trade in Chinese

goods and continues to threaten to impose even more tariffs on remaining Chinese imports to try to change Chinese behavior.

• Congress passed legislation to bolster CFIUS, the chief committee in the United States responsible for reviewing the country’s inbound investment, and to codify additional export control requirements.

Defense

Defense ties continue to deteriorate as the United States and China debate the legality of Beijing’s activity in the South China Sea. China continues to militarize islands in the region, despite an international ruling denying its sovereignty claims.• In response, the United States in 2018 restricted Chinese participation in the Rim

of the Pacific exercise – the world’s largest maritime exercise. • Last year, a Chinese vessel almost collided with the USS Decatur during a

freedom of navigation patrol, highlighting how a skirmish could escalate into a broader conflict.

Influence Operations

The Trump administration has accused China of engaging in significant influence operations and even looking to use propaganda to influence American elections. • U.S. authorities indicted multiple Chinese citizens accused of corporate

espionage last year.• Congress remains worried about China’s role on American college campuses,

especially through state-sponsored Confucius Institutes, and U.S. officials have begun implementing visa restrictions on Chinese students.

“The United States must take strong, smart, and strategic action against China’s brazenly unfair trade policies.”

Speaker Nancy PelosiU.S. House of Representatives

Several of the largest Asian economies showed signs of weakness in 2018, posing challenges to their governments’ reform agendas in 2019. Global trade tensions have exacerbated economic difficulties in China, Japan, South Korea, and India, reducing regional and global growth prospects. Additionally, larger trends in the global economy are threatening economic stability. An economic downturn in China,

aggravated by a trade war with Washington, could further damage elements of the regional economy. What to Watch: deleveraging vs. stimulus in China, populist spending in India, government popularity in South Korea, monetary policy in Japan.

Senator Chuck SchumerU.S. Senate Minority Leader

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Copyright © Free Vector Maps.com

China continues to militarize manmade fortifications in the South China Sea, despite a 2016 ruling from the Permanent Court of Arbitration denying the legitimacy of Beijing’s sovereignty claims under its controversial “nine-dash line.” The near-collision of U.S. and Chinese military vessels in 2018 highlighted the rising risk of a conflict escalating from an accidental interaction.

South China Sea Sovereignty Debates

In 2017, India and China engaged in a 72-day standoff on their shared border in the Doklam region of Arunachal Pradesh. Although leaders from both countries worked to calm tensions in 2018, the fundamental dispute remains, prompting increased militarization and continued instability.

The India-China Border

REGIONAL FLASHPOINTS

Taiwan Strait

Japan and South Korea’s relationship continues to suffer as the two debate legacy issues from World War II – including Japan’s exploitation of South Korean “comfort women” and controversial backpay issues from the wartime era.

Rising Tension on Historical Questions

China and Taiwan remain locked in a bitter feud as Tsai Ing-wen continues to serve out her term as Taiwanese president. In 2018, Beijing increased pressure on Taiwan, which it considers a breakaway province. While conflict may be unlikely given U.S. support for Taiwan, Chinese pressure will continue to mount in the months and years ahead.

TaiwanStrait

China and Japan continue to debate sovereignty over the Senkaku Islands, located in the East China Sea, and which Beijing calls the Diaoyu Islands. Although Japanese Prime Minister Shinzo Abe and Chinese President Xi Jinping have engaged in diplomacy over the dispute, this issue remains unresolved.

Senkaku Islands and the East China Sea

A round the Indo-Pacific, countries have invested heavily in enhancing military capabilities. Particularly as China demonstrates its strength in the region, other powers have begun considering how they will defend themselves in a new geostrategic environment. Geopolitical hotspots from the East and South China Seas to the India-China border have the potential to burst into conflict if not effectively

managed. But even absent conflict in one of these consequential regions, growing defense expenditures across Asia will heighten tensions. In 2018, countries across the Indo-Pacific spent a combined estimated total of USD 450 billion on defense. Within 10 years, the region is expected to surpass North America as the world’s largest purchaser of military weaponry. By 2035, half of the world’s submarines are expected to patrol waters around the region. Governments and businesses must be ready to embrace opportunities and consider challenges that accompany an increasingly militarized Asia. What to Watch: flaring of tension in hotspots, defense acquisitions focused on power projection, more frequent and increasingly complex multilateral military exercises.

5 Asia’s Powers Flex Their MusclesRising Geostrategic Risk

Beijing has embarked on significant projects to bolster its power projection capabilities, including: • Launching its first domestic aircraft carrier in 2017, with

commissioning anticipated in 2019• Establishing a constellation of 35 satellites that will enable global

coverage• Operating four nuclear-powered ballistic missile submarines, five

nuclear-powered general-purpose attack submarines, and 47 diesel-electric submarines – with plans to expand this fleet up to 78 vessels by 2020

• Emphasizing long-range precision strike capabilities by extending bomber flights past the first island chain

China

Defense budgets have ballooned throughout the region as countries look to increase their military capabilities:• China – Since President Xi Jinping took power in 2013, China’s military spending has increased rapidly, with Chinese

expenditures accounting for almost half of the region’s combined total.• Japan – The government plans to spend USD 239.5 billion on defense over the next five years.• South Korea – The government increased the 2019 defense budget 8.2 percent year-on-year, the largest annual

increase since 2008.• India – Last year, for the first time, the budget of the Indian Armed Forces eclipsed the French Armed Forces,

making India the world’s fifth-largest defense spender.

Rising Defense Budgets


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China



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Tashkent

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Copyright © Free Vector Maps.com

China continues to militarize manmade fortifications in the South China Sea, despite a 2016 ruling from the Permanent Court of Arbitration denying the legitimacy of Beijing’s sovereignty claims under its controversial “nine-dash line.” The near-collision of U.S. and Chinese military vessels in 2018 highlighted the rising risk of a conflict escalating from an accidental interaction.

South China Sea Sovereignty Debates

In 2017, India and China engaged in a 72-day standoff on their shared border in the Doklam region of Arunachal Pradesh. Although leaders from both countries worked to calm tensions in 2018, the fundamental dispute remains, prompting increased militarization and continued instability.

The India-China Border

REGIONAL FLASHPOINTS

Taiwan Strait

Japan and South Korea’s relationship continues to suffer as the two debate legacy issues from World War II – including Japan’s exploitation of South Korean “comfort women” and controversial backpay issues from the wartime era.

Rising Tension on Historical Questions

China and Taiwan remain locked in a bitter feud as Tsai Ing-wen continues to serve out her term as Taiwanese president. In 2018, Beijing increased pressure on Taiwan, which it considers a breakaway province. While conflict may be unlikely given U.S. support for Taiwan, Chinese pressure will continue to mount in the months and years ahead.

TaiwanStrait

China and Japan continue to debate sovereignty over the Senkaku Islands, located in the East China Sea, and which Beijing calls the Diaoyu Islands. Although Japanese Prime Minister Shinzo Abe and Chinese President Xi Jinping have engaged in diplomacy over the dispute, this issue remains unresolved.

Senkaku Islands and the East China Sea

A round the Indo-Pacific, countries have invested heavily in enhancing military capabilities. Particularly as China demonstrates its strength in the region, other powers have begun considering how they will defend themselves in a new geostrategic environment. Geopolitical hotspots from the East and South China Seas to the India-China border have the potential to burst into conflict if not effectively

managed. But even absent conflict in one of these consequential regions, growing defense expenditures across Asia will heighten tensions. In 2018, countries across the Indo-Pacific spent a combined estimated total of USD 450 billion on defense. Within 10 years, the region is expected to surpass North America as the world’s largest purchaser of military weaponry. By 2035, half of the world’s submarines are expected to patrol waters around the region. Governments and businesses must be ready to embrace opportunities and consider challenges that accompany an increasingly militarized Asia. What to Watch: flaring of tension in hotspots, defense acquisitions focused on power projection, more frequent and increasingly complex multilateral military exercises.

5 Asia’s Powers Flex Their MusclesRising Geostrategic Risk

Beijing has embarked on significant projects to bolster its power projection capabilities, including: • Launching its first domestic aircraft carrier in 2017, with

commissioning anticipated in 2019• Establishing a constellation of 35 satellites that will enable global

coverage• Operating four nuclear-powered ballistic missile submarines, five

nuclear-powered general-purpose attack submarines, and 47 diesel-electric submarines – with plans to expand this fleet up to 78 vessels by 2020

• Emphasizing long-range precision strike capabilities by extending bomber flights past the first island chain

China

Defense budgets have ballooned throughout the region as countries look to increase their military capabilities:• China – Since President Xi Jinping took power in 2013, China’s military spending has increased rapidly, with Chinese

expenditures accounting for almost half of the region’s combined total.• Japan – The government plans to spend USD 239.5 billion on defense over the next five years.• South Korea – The government increased the 2019 defense budget 8.2 percent year-on-year, the largest annual

increase since 2008.• India – Last year, for the first time, the budget of the Indian Armed Forces eclipsed the French Armed Forces,

making India the world’s fifth-largest defense spender.

Rising Defense Budgets


Japan

South Korea


















China



8.4

8.2

8.6

8.8

9

9.2

JUL2017


8

AUG2017

SEP2017

OCT2017

NOV2017

DEC2017

JAN2018

FEB2018

MAR2018

APR2018

MAY2018

JUN2018

AUG2018

SEP2018

OCT2018

NOV2018

2000

2500

3000

3500










Defense














A S I A P O W E R T R E N D S

Japan

Global trade tensions and robust competition from Chinese manufacturers weighed on South Korea’s economy in the second half of 2018, causing the Bank of Korea to downgrade its growth outlook for 2019. As growth slows and unemployment remains high, South Korean President Moon Jae-in will face added pressure to solve South Korea’s economic challenges. Although Moon’s diplomatic outreach to North Korean leader Kim Jong-un has bolstered Moon’s popularity, continued economic malaise may test even his most ardent supporters. Moon has already fired multiple senior members of his team, even as he works to convince the Korean people to stay the course with his economic policies.

South Korea

In 2018, the rupee underperformed, registering a double-digit slide on the back of India’s widening current account deficit. While a weaker currency may benefit the government’s “Make in India” policy, the country is still a net importer, and its companies are exposed to currency fluctuations through their external debt obligations. India continues to confront an unsettled debate between nationalists favoring more populist measures in the face of consequential national elections and those advocating for further economic reforms aimed at attracting increased foreign direct investment. Despite the headwinds, India remains one of the world’s fastest-growing economies.

India

As Japanese Prime Minister Shinzo Abe begins a new three-year term, he is prioritizing economic growth, especially as his goal of achieving sustained two-percent inflation – a key pillar of Abenomics – remains unmet. Concerns about regional bank profitability and inflated asset prices are expected to intensify this year, and Bank of Japan Governor Haruhiko Kuroda has already expressed concern about continuing ultra-low interest rates, especially as the U.S. Federal Reserve considers rate hikes. However, even as banks criticize the government’s policies, Abe and Kuroda will be reluctant to abandon stimulus measures.

Source: Bank of Japan

Source: U.S. Federal Reserve

Source: Statistics South Korea

.02

0

.04

.06

.08

1

1.2

JAN2016

JUL

JAPANESE INFLATION AND MONEY SUPPLY GROWTH - PERCENT CHANGE -

-.02

0.5

2.5

3

3.5

4

4.5

1.5

2

1

JULJAN2017

JAN2018

JUL OCTAPR OCT APROCTAPR

Core Inflation YoY Growth (left axis)

M2 YoY Growth (right axis)

4.3

JAN2017

SOUTH KOREAN UNEMPLOYMENT RATE - IN PERCENTAGE -

4.2

4.1

4

3.9

3.8

3.7

3.6

3.5APR2017

JUL2017

OCT2017

JAN2018

APR2018

JUL2018

OCT2018

Moon Jae-in Becomes president

66

64

62

68

70

72

76

DEC 17

INDIAN RUPEE AGAINST THE U.S. DOLLAR - DAILY CLOSING VALUE -

JAN 18 FEB 18 MAR 18 APR 18 MAY 18 JUN 18 JUL 18 AUG 18 SEP 18 OCT 18 NOV 18 DEC 18

60

58

74

1 5

In 2018, President Trump engaged in unprecedented diplomacy with North Korean leader Kim Jong-un. Despite months of harsh rhetoric between the two sides, with Trump at one point calling Kim “Rocket Man” and threatening North Korea with nuclear annihilation, the new détente, brokered and encouraged by South Korean President Moon Jae-in, represented a marked change. Though Trump and Kim have pursued personal diplomacy, the

situation remains volatile. Both sides expect the other to initiate the first major move, with Pyongyang demanding sanctions relief before denuclearization, while Washington remains hesitant to provide full relief until Kim gives up significant elements of his nuclear arsenal. Trump may feel the need to redefine what “success” means, especially if he realizes that denuclearization is not realistic. The result is a still dangerous Korean peninsula ripe for conflict. What to Watch: whether North Korea’s arsenal grows or slows, Pyongyang’s cooperation with international inspections, the extent of U.S. sanctions relief.

7 The Dangerous Gap Between “Success” and Denuclearization

Trump’s Perilous Diplomatic Gambit with North Korea


Kim announces the installation of a

nuclear button at his desk

Satellite images reveal North Korea

is continuing missile

development at 13 hidden bases

Kim and Moon meet for the first time at

Panmunjom in the demilitarized zone

Kim and Trump hold summit in Singapore, where Trump

“fell in love” with Kim

North Korea participates in Pyeongchang

Olympics

January February April June November

2018: A Tumultuous Year


After returning from his meeting with Kim in Singapore, Trump declared the North Korean nuclear threat to be over. However, there has been little action from Pyongyang that would validate that claim. Washington continues to demand that North Korea take concrete steps toward denuclearization, while Pyongyang has demanded sanctions relief before making any further concessions.

The USD value of North Korean trade prohibited

by U.S. sanctions enacted in 2017

The number of illicit oil deliveries North Korea is

estimated to have received between January and

August 2018

The USD value of transactions that Chinese banks helped

North Korea process through the U.S. financial system from

2009 to 2017

2.2 billion1481 billion

Meanwhile, North Korea has not abandoned its nuclear weapons program. In November 2018, satellite imagery revealed that North Korea had continued its missile program, including potentially nuclear-capable missiles, at 13 hidden bases. If a major new revelation or provocation emerges, the present diplomatic situation will become unsustainable and bring back the threat of dramatically heightened tensions on the Korean Peninsula.

The Rhetoric Versus the Reality

U.S. officials have repeatedly emphasized that the maximum-pressure sanctions campaign remains in place, but President Trump’s warm words for North Korea’s leader, combined with ongoing inter-Korean diplomacy, have reduced China and Russia’s determination to comply with the UN sanctions regime. UN documents reveal that China has continued illicit exports to North Korea through mid-ocean ship-to-ship transfers, while the Moon administration has moved ahead on economic reintegration with North Korea, reconnecting inter-Korean rail links and potentially reopening the Kaesong industrial park. In this environment, Trump will likely come under increasing pressure to provide sanctions relief, even absent total denuclearization by North Korea.

New and disruptive technologies are rapidly changing the business landscape across the Indo-Pacific and reconfiguring the way governments, businesses, and consumers engage with one another. Governments in the region have sought to keep up with these changes by unveiling new regulatory regimes aimed at addressing concerns around privacy, security, unemployment, and sovereignty. New policies will

continue to be implemented as governments work to respond to the rapid pace of innovation in an environment of heightened anxiety and uncertainty. What to Watch: demands for data localization, expanded regulation of internet content, increasing antitrust scrutiny.

The number of AI technical professionals in China

The percentage of 2017 AI startup funding that went to China

The number of Chinese-backed deals for U.S. AI startups in 2017

50,00048 31

AI’s Rise in China

China has made massive commitments to advancing artificial intelligence (AI) research and development efforts. The Chinese government has publicly announced the goal of matching the United States’ AI capabililties by 2020 and leading the field by 2030. Beijing views AI not just as a necessary technology and market opportunity but also as a tool for security. Chinese President Xi Jinping said that China must “enhance the combination of AI and social governance and develop AI systems for government services and decision-making.”

CHINESE AI INVESTMENT Australia

0

5

10

15

20

2013 2014 2015 2016 2017 2018 H1

- USD BILLIONS -

CHINESE AND U.S. AI PATENT-RELATED PUBLICATIONS

0

100

200

300

400

500

600

700

2013 2014 2015 2016 2017

-TITLE AND ABSTRACT KEYWORD APPEARANCES-

8 Privacy, Artificial Intelligence, and Security Concerns Define a New Regulatory Landscape

Techlash


Source: Financial TimesSource: Yiou

CybersecurityPolicy

Ride-Hailing in Southeast Asia

South Korea’s Crypto Conundrum

India is currently finalizing a draft data-protection bill that may introduce new data localization requirements, effectively forcing companies to store critical user data on local servers. The move follows a similar measure introduced by the Reserve Bank of India in April 2018, which generated strong opposition from multinational payments companies, though they are now coming into compliance with the central bank’s directive.

Data Localization

Vietnam’s recently passed cybersecurity law provides Vietnamese authorities with broad powers to force foreign firms that provide services to Vietnamese users online to localize their data and open representative offices in Vietnam. The Vietnamese government is now in the midst of finalizing regulations that define the companies, types of data, and circumstances that will be covered by the legislation. The government is hoping to strike a balance between security concerns and growth in the digital economy, as it finalizes the law’s implementing regulations. Over the course of 2019, Vietnamese authorities will also introduce new measures to govern data and online conduct, including social media behavior.

Southeast Asian governments surprised many global tech companies when they sought to aggressively restrict acquisitions that threatened competition. Ride-hailing company Grab’s acquisition of Uber’s business prompted antitrust investigations by regulators in Singapore, Malaysia, Vietnam, and the Philippines. The Competition Commission of Singapore took the lead by charging the two companies USD 9.5 million in fines and also issued unprecedented orders requiring Grab to preserve the conditions for market entry by other players. The Grab-Uber merger has led competition authorities to strengthen their regulatory tools and increase their scrutiny of tech companies.

After a year that saw investors lose substantial sums in a worldwide sell-off of crypto assets, regulators in Asia have moved to aggressively crack down on cryptocurrencies. In South Korea, intense public pressure during 2018 led to Seoul reversing a ban on crypto trading, but regulators still fear the effect that Bitcoin and other cryptocurrencies’ popularity will have on the country’s economy.

REGIONAL CASES


Amid increasing trade tensions and rising labor costs, existing supply chains are poised to undergo a significant structural shift, presenting opportunities and challenges for corporations and governments in the region. The U.S.-China trade dispute has challenged firms from both countries to reevaluate their current operations. Southeast Asia and India appear set to become the primary beneficiaries of market

shifts, especially given their lower wages relative to China. What to Watch: foreign businesses leaving China, manufacturing growing in Southeast Asia, changing prices of intermediate goods.

9 Companies and Countries Adjust to New Realities

Supply Chain Shake-Up

The State of Manufacturing in Asia

China’s tremendous growth since the early 2000s has been the dominant factor in Asian manufacturing to date. China has driven global manufacturing output, becoming the factory for the world and fueling global growth, but this narrative is beginning to change. The emergence of India, Vietnam, Thailand, and other countries as industrial economies will challenge China’s supremacy even without the additional burden from U.S. tariffs.

Source: World Bank; National Bureau of Statistics

ASIAN MANUFACTURING VALUE ADDED- PERCENT GROWTH -

INDONESIA INDIA

2013 2017-3

0

3

6

9

12

15

CHINA JAPAN THAILAND VIETNAMSOUTH KOREA

2014 2015 2016


Source: Japan External Trade Organization


Retreat from South ChinaSouth China – and Guangdong province in particular – has long served as the export-growth engine of China. However, the region is already struggling to maintain its existing manufacturing output, as producers consider alternatives in the face of U.S. tariffs. In October 2018, the American Chamber of Commerce in South China found that 30.2 percent of its members had begun to consider relocating operations outside of the region.

Wage Pressure

While China and the United States have engaged in an expensive trade war, other countries in the region have not only shunned protectionism but actively embraced cooperation, further incentivizing the shift of global supply chains. Vietnam, which has most-favored-nation trade status with the United States and has finished negotiations for a free-trade agreement with the European Union, has rolled out substantial tax incentives for foreign manufacturers looking to source exports from Vietnam. Through Prime Minister Narendra Modi’s “Make in India” program, New Delhi has sought to attract foreign manufacturers to base production in the country, allowing 100-percent foreign ownership in almost all non-security-related sectors.

Rising wages in industrialized economies have incentivized companies to look for cheaper labor pools in industrializing South and Southeast Asia. The latter in particular has become popular due to the sheer number of moderately skilled laborers willing to work for substantially less than Chinese workers, as a survey of Japanese companies in Asia found. While moving facilities to Southeast Asia and India presents obvious costs, foreign manufacturers may stand to benefit in the long run by relocating to countries with cheaper labor pools. While new trade deals, including the Comprehensive and Progressive Agreement for Trans-Pacific Partnership, may put upward pressure on wages in Southeast Asia in the medium term, businesses will still likely benefit from reduced operating costs in the years ahead.

Countries Incentivize the Transition

WAGES AT JAPANESE MANUFACTURING COMPANIES IN ASIA

- AVERAGE ANNUAL USD SALARY IN 2017- Australia

India

South Korea

China

32,712

Thailand

Malaysia

Indonesia

Philippines

Vietnam

10,131

6,997

5,900

5,421

4,102

3,982

3,673

0 10000 20000 30000


Asia Will Be Most Affected by Climate Change

A sian leaders are increasingly aware of the very real effects of climate change and the costs that their countries may incur as they continue to burn fossil fuels. But growing energy demand has made it difficult to reduce the region’s reliance on polluting energy sources. Additionally, increased economic uncertainty has threatened ambitious plans to halt emissions. Emblematic of this dichotomy, Asia is

both the largest consumer of coal and the largest investor in renewables – and the region also stands to face the most challenges due to climate change. What to Watch: coal and oil consumption, investments in renewables, climate change mitigation measures across the region.

More than any other region in the world, Asia is expected to bear the brunt of climate change impacts. Pollution more broadly has already begun to take a toll on Asian populations, even prompting social unrest in countries with particularly challenging environmental conditions, while shifting monsoon patterns risk adversely affecting agriculture, spurring further rapid urbanization. Sea-level rise threatens mega-cities along the Chinese coast and will critically impact other countries, including Vietnam, Indonesia, and Bangladesh. Meanwhile, on smaller islands in the South Pacific, people are already facing existential challenges and the prospect of having to permanently evacuate their homelands. Climate change therefore will add to the pressures already driving migration both within and across countries throughout the region.

10 Fossil Fuels and the Climate Change Economy

Climate Change Conundrum

Source: Plos One

ASIAN LAND AREA VULNERABLE TO RISING SEA LEVELS

PERCENT OF TOTAL LAND AREA

2.6

2

40 7.3

6.8

5.9

9.1

6.820.2

6

4.66.5

0 50


Despite Asia’s massive consumption of fossil fuels, the region is the world’s leading investor in renewable energy technology. In the wake of President Trump’s decision to withdraw the United States from the Paris Climate Agreement, some Asian countries have sought to cast themselves as global leaders on the issue. India, for example, is currently on track to meet its climate commitments ahead of schedule, and Japanese Prime Minister Shinzo Abe has said Japan will prioritize climate change when it hosts the G20 Summit in 2019. China, too, has maintained its commitment to achieving the goals set in Paris and opened the world’s largest carbon exchange in December 2017.

Major Asian economies continue to rely on coal and oil as their primary sources of energy, even as the region’s leaders have ramped up rhetoric around addressing the threats posed by climate change. India, for example, is expected to overtake China as the largest source of growth in oil demand by 2024, while China is building out coal power infrastructure in neighboring countries as part of its Belt and Road Initiative.

Asia Is the Largest Consumer of Fossil Fuels

Asia Is the Largest Investor in Renewables

Source: International Energy Agency

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