Thayer Consultancy

ABN # 65 648 097 123

Background Briefing: Scarborough Shoal: China Applies Economic Pressure Carlyle A. Thayer June 25, 2012

[client name deleted] As you know, Philippine Pres. Benigno Aquino III recently decided to withdraw the two Filipino vessels in Scarborough, citing bad weather. After Chinese government and fishing vessels did not follow suit, Aquino told reporters that he might order the Filipino ships back to Scarborough Shoal to safeguard Philippine sovereignty if the Chinese ships and boat would not leave the area. 1. Do you think the economic squeeze that China applied to the Philippines (more stringent checks on Philippine banana exports that held up several containers of the fruit in Chinese ports, decision by some Chinese travel agencies to stop tours to the Philippines etc.) played a role in pressuring Aquino to ease his hardline stance a bit and order the 2 Philippine ships back to port, citing the bad weather at the time as an excuse? ANSWER: I do not think Chinas economic squeeze on the Philippines played a major role in President Aquinos decision to withdraw ships from Panatag Shoal. The banana issue was quickly resolved. China is the third largest market for bananas from the Philippines but the market is small. US $60 million bananas were sold to China in 2011. The suspension of charter flights for tourists apparently continues. This led to some domestic pressure to resolve the matter but Chinese tourism to the Philippines, while important, is not decisive. China is the fourth largest source of tourists for the Philippines. Reports suggest that 1,500 tourists stayed at home. They spend on average US $200-300 per day for a stay of 2-3 days. This means a loss of US $1.35 million. The more economic pressure China applies to the Philippines the more counterproductive it becomes in Chinas relations with the rest of Southeast Asia. The international community will ask are economic sanctions of this nature a reflection of Chinas peaceful rise? 2. If China's economic squeeze did not play a major part in Aquino's decision to temporarily withdraw from the shoal, what factor played a major role in that decision?

2 ANSWER: I think the weather cannot be ruled out. As the storm season approaches it will be unsafe to keep vessels at sea. But I think the larger issue was one of sustainability. There are two aspects of this. First, could the Philippines sustain its presence without technical problems such as mechanical breakdowns and fuel becoming an issue? Second, could the Philippines sustain a policy of confrontation with China indefinitely? Was the game worth the candle? In other words was the deployment of two ships to Panatag Shoal the best use of marine resources? Could they have been better deployed to the Kalayaan Island Group? In the end the Philippines faced a no win situation. China would have outlasted the Philippines. The longer this dragged on the more pressure would be put on Manila to resolve the matter. The attention of the international community would have moved to other matters. In this situation it is up to the Philippines to be portray itself as the victim not the protagonist. The Philippines needs to use nimble diplomacy to put the onus on China to respond. 3. Is the Philippines' economic engagement with China substantial enough in the first place for China to use it as a leverage to pressure the Philippines in the Scarborough and South China Sea territorial issues? ANSWER: China is the Philippines third largest trade partner. According to my calculations, China-Philippines trade is growing at over 30% per annum and the Philippines maintains a small surplus. It sells more to China than it imports. Total two way trade in 2011 was around US $33 billion. Both sides have set a goal of US $60 billion by 2016. Chinas trade with the Philippines is conducted under the umbrella of the ChinaASEAN Free Trade Agreement. China must take into account any collateral damage arising from using the economic lever against the Philippines. Secondly, China seeks Filipino resources such as minerals and liquefied natural gas. 4. Do you think Aquino will sacrifice trade with China, or some parts of it, and press for a hardline position in Scarborough just to be seen he's complying with his constitutional duty to protect Philippine territory? His key aides have said he may face impeachment complaints if he would be seen as waivering on this constitutional duty. ANSWER: So far the dispute over Panatag Shoal has involved civilian ships. No force or threat of force has been used. The Aquino government may find its nationalist rhetoric will come back to haunt it. The Philippines cannot prevent China from occupying Panatag Shoal if it wanted to, nor can the Philippines prevent Chinese paramilitary ships from being stationed there indefinitely. China is more likely to seek a diplomatic solution to the current standoff than it is likely to continue to press the Philippines. Chinas reputation has been staked on its call for bilateral negotiations. That is the most likely route. Both sides could shelve their sovereignty claims to enable joint fishing under mutual supervision. The Aquino government should take advantage of domestic pressures to defend sovereignty to obtain authorization for continued funding for the modernization of

3 the AFP. This is a long term solution but without a credible minimal deterrence, the Philippines is in a weak negotiating position. The Philippines could also hang tough with its fellow ASEAN members and decline to endorse a weak draft Code of Conduct. 5. The Philippines would suffer but not fall under if China squeezes it economically over territorial rifts, right? How far can China apply such an economic weapon to gain leverage in the territorial disputes considering the international community is watching and maybe alarmed by such behavior of a rising global power? ANSWER: The Philippines would be economically damaged if China really applied economic levers against the Philippines. But this would not be pretty. Chinese investors in the Philippines would get their fingers burned as well. China is cautious, it is likely studying the lessons of the suspension of banana imports and the disruption to tourism to see impact this had not only on the Philippines but regionally and internationally. So far China has refrained fro causing major economic damage. China will move quickly to exploit the situation now that the Philippines has withdrawn its ships. China is motivated to portray itself as a reasonable power. Picking on the Philippines is precisely the gun boat diplomacy that China so vociferously condemns.

Suggested citation: Carlyle A. Thayer, Scarborough Shoal: China Applies Economic Pressure, Thayer Consultancy Background Brief, June 25, 2012.