A vital partner: The country has a complex relationship with the giant to the north

China is one the Philippines’ most important trading partners. In 2012 it was number three in total bilateral trade, behind the US and Japan, but it became number two by July 2013 and was number one for imports to the Philippines by that time (up from number three). The trade relationship is certainly a vital one. Yet beyond the numbers, the situation is highly complex. China is no doubt a potential market for the Philippines and a potential source of foreign direct investment (FDI), but it could also be an economic threat, as it could put local manufacturers out of business and seek to exploit the country’s natural resources.

Further complicating matters is the strategic overlay. China and the Philippines are in dispute over a number of islands, reefs and ocean formations within the Philippines’ 200-mile exclusive economic zone ( Vietnam, Malaysia, Brunei and Taiwan also have overlapping claims in the area). The conflict intensified in 2012 when Chinese fishing boats entered the waters around Scarborough Shoal, which is claimed by both countries. The Philippines said the Chinese were poaching endangered species in the area. In late 2013 China’s first aircraft carrier, the Liaoning, was deployed to the South China Sea at about the same time that Beijing established an air-defence identification zone around disputed territory near Japan and South Korea.

The Philippines is seeking a resolution. In January 2013 it filed a claim in the UN International Tribunal on the Law of the Sea. But China has rejected the jurisdiction of the body and refused to become a party to the proceedings. It has, however, separately agreed to work to peacefully resolve the dispute.

OTHER MEANS: While tension has been brewing for years, and direct conflict has been avoided, the concern is that victory will be achieved by other means, using economic coercion, divide-and-conquer diplomacy and suggestions that cooperation will be rewarded. China appears to be flexing its muscle. Beijing offered $100,000 in aid to the Philippines following Typhoon Haiyan, much less than Japan’s $10m, New Zealand’s $1.6m and the Vatican’s $4m. Analysts suggested that the paltry sum was related to the dispute.

The low-intensity conflict has played out in other areas. Chinese Customs held up Philippine rice bound for a trade show in Nanning in September 2013, and President Benigno Aquino III was disinvited to the fair, at which the Philippines was the country of honour. The Chinese Foreign Ministry had insisted that the Philippines withdraw its legal complaint over the disputed territory as a condition for the president’s invitation. In 2012 restrictions were placed by China on the import of Philippine bananas, and growers said that the move was a direct result of the territorial dispute. Even without the strategic overhang, trade and investment between the two countries are bound to be problematic going forward.

China’s economic push over the past three decades has come, some argue, at the expense of South-east Asia. Its devaluation of the renminbi in the early 1990s attracted a good deal of manufacturing that otherwise might have gone to ASEAN member states, and ASEAN suffered as a consequence. After the Asian financial crisis, FDI gravitated to China at the expense of smaller countries in the region. ASEAN did become a supplier of intermediate goods to China over time, playing a productive and profitable a role in China’s export machine, and recorded a surplus with China for a number of years. However, that did not last, and in 2012 ASEAN had a deficit with China.

CAFTA: In part, the deficit was a result of the recession in the West. As exporting to the US and Europe became more difficult following the financial crisis that began in 2008, China turned its attention to relatively untapped markets. It found South-east Asia a perfect target for its low-priced consumer items and high-tech products. While ASEAN countries are good at manufacturing, they cannot match China’s costs, given that country’s economies of scale and the low wages of workers in the interior. Also, accusations of dumping against China are not uncommon in ASEAN.

However, what really turned the tide for China was the China-ASEAN Free Trade Agreement (CAFTA), which came into effect in 2010 and was designed to end tariffs on 90% of trade between the signatories. While hailed as a great step in creating one of the world’s largest and most dynamic economic blocs – both in terms of manufacturing power and consumer demand – China has been accused of using it unfairly. For example, it is said to have failed to implement required tariff reductions despite the fact that others have, leading to unfair trade flows and a loss of productive capacity by those that have followed the rules. The concern is that ASEAN will lose more than it gains from open trade with China. A NEW ERA?: China is trying to counter concerns about its economic and strategic ambitions by mounting a charm offensive. It talks of balanced trade with the region that will pass $500bn by 2015 and $1trn by 2020. At the ASEAN summit in Brunei in October 2013, Chinese Prime Minister Li Keqiang spoke of a new era of cooperation between his country and the South-east Asia grouping. China also splashed around development funds and committed to more FDI. The efforts of China were particularly notable, and some argued quite effective, because US President Barack Obama declined to attend the summit in Brunei due to the partial shutdown of the US government.

Yet China is still viewed with some suspicion. There are fears that it will continue to see CAFTA as a tool to promote its own exports rather than as a true free trade agreement. Worse is the possibility that in implementing its economic policies it will use them to achieve strategic ends, being generous to countries that support its territorial arguments and hostile to those that do not. The worry is that the rhetoric that politics and economics remain separate is just talk and that benefits will accrue to those who cooperate.

OPPORTUNITY: China does represent a great opportunity. It is set to become the largest trading partner for the Philippines and its largest export market. It is also interesting for the Philippines on the investment side. As it stands now, the Philippines has invested far more in China ($2.5bn) than China has in the Philippines ($1bn). If this gap can be narrowed and the total increased, considerable industrial capacity could be established in the Philippines.

The big picture is simply too attractive to ignore. China is one of the largest markets in the world and one of the fastest-growing economies. For the Philippines, it will be a vital source of economic growth in the future, but the process could be difficult to manage.

China has a trade surplus with the Philippines, and it would be a problem for the country if the gap remains or widens. Meanwhile, the abundance of trade with China may be more of a curse than a blessing. It will be difficult to manoeuvre given this level of dependence, and the Philippines will have to tread carefully. It will have to work to keep politics and trade separate, and it will have to ensure that it is not outsmarted by China, which has tended to view free trade more as a strategy than an ideal.

The best hope for the Philippines in hedging its China bets is by nurturing its other relationships. The country must stay engaged with ASEAN and needs to make sure the group remains unified. China’s strategy is to pick favourites based on those who are most cooperative. If ASEAN resists that tactic and speaks with one voice, it will be better set to negotiate a true level playing field. The Trans-Pacific Partnership might also help, as it will link the Philippines better with the open economies of the region and of the world.

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The Report: The Philippines 2014

Trade & Investment chapter from The Report: The Philippines 2014

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